RBA: Market response to today's rate decision - Westpac

In view of analysts at Westpac, there is a stronger link between appreciation in the A$ and the RBA's economic forecasts.

Key Quotes

“We went into today's RBA fully expecting to see a reasonable shift in the RBA commentary on FX. For the last 15 consecutive meetings, the RBA has used the same or similar language i.e. that "further appreciation could/ would complicate the adjustment process". With the A$ up circa 5% from the previous meeting, it certainly appeared to be time for a change.”

“What might the RBA have said? We expected to see commentary along the lines of Deputy Governor Guy Debelle in Adelaide i.e. that 'a lower exchange would help'.”

“Instead, the RBA noted that "An appreciating exchange rate would be expected to result in a slower pick-up in economic activity and inflation than currently forecast". This suggests a stronger link between appreciation in the A$ and the RBA's economic forecasts. Further appreciation would no longer complicate; rather it "would be expected to result in a slower pick-up in economic activity and inflation than currently forecast".”

“To be sure, the RBA acknowledges that the strength of the A$ has partly reflected a lower US dollar and that "conditions in the global economy are continuing to improve"; that "the Bank's forecasts for the Australian economy are largely unchanged"; "business conditions have improved and capacity utilisation has increased"; "employment growth has been stronger over recent months" and that "commodity prices have generally risen recently". None of this could really be seen as negative for the A$.”

“The A$ is expensive in our eyes, being above the top end of our fair value band. However, given the backdrop of a weak US$, rising commodity prices and strong risk sentiment, an expensive A$ is to be expected. It's thus not obvious that today's guidance will have a significant impact on the A$ near term though it should clearly caution on expectations for further strength.”

“I do expect to see a weaker A$ over time on the basis that the Fed raises rates/ tapers before year end; that commodity prices will fall post the NPC in China and that risk aversion will rise. It’s not obvious that the current high will be THE high before we start to see that weakness come through, but it will be close.”

“Rates Perspective

Bonds mirrored the AUD’s whipsaw moves on the statement release, with an initial rally in futures very quickly faded as the detail of the statement turned out to be relatively balanced. Market pricing is now generally about unchanged, with little discernible impact on market RBA expectations. A rate hike still fully factored in by around December next year, and half a chance by June. 

The “as expected” CPI interpretation gave little fuel for bond bulls, except as the potential for continued AUD appreciation entered the discussion (see paragraphs above). Indeed we see this statement as containing more for the FX market than rates. As such, while the more explicit linkage from AUD to economic outcomes will be interesting to watch play out, we don't see a strong directional driver here for rates... yet.  

All-in-all, this did does not markedly change the equation for rates markets in the short term, but the even-handed statement (and steady market reaction) leave us persuaded that front-end carry trades are still the right response, especially with growth risks still skewed to the downside.”