RBA Preview: A 16% Chance of a Hike

The RBA decision will likely be about what officials say rather than what they do. The cash rate is likely to remain at 4.75% but policymakers may boost AUD by signaling a hike in July. AUD will weaken if officials dont hike rates or signal an impending rise.

Of 28 economists surveyed by Bloomberg, 23 expect no change and 5 expect a quarter-point hike to 5.00%. The OIS market is pricing in a 16% chance of a hike and the rates market is pricing in 50 bps in tightening in the next 12 months. The Australia dollar was volatile on Monday ahead of the decision and traded in a nearly 200 pip range against USD. The wide range reflects limited certainty surrounding the decision and sinking risk appetite.

We see no change in rates as a virtual certainty because of recent disappointments in economic data. Australian GDP fell 1.2% in Q1 compared to the -0.7% expected. Although the the reading was heavily skewed by floods and the Japanese disaster it was still the worst in 20 years. Other indicators have also been weak including May employment (-22K), company profits, job ads, consumer sentiment and some housing metrics. External sentiment may also weigh on policymakers with the US economy showing troubling signs.

Still, a hike by Sept is almost universally expected so traders are grappling with the question of whether it will be in July or Aug. The underlying economy remains in mining a resource boom; indicators of investment have been good and last weeks retail sales data beat expectations. Inflation is also above target and in the May 3 RBA meeting, Gov. Stevens said: recent information suggests that the marked decline in underlying inflation from the peak in 2008 has now run its course.

In the event of a surprise hike, AUD could gain 100 pips or more. If there is no hike, the knee jerk reaction could will push AUD 30-40 pips lower against USD and JPY. The rest will depend on the statement.

Remember that the RBA does not always signal hikes. They have no code words, like Trichets strong vigilance. The most recent hike came in Nov. 2010. At the meeting prior, Stevens statement said:

The last time the RBA foreshadowed hikes was Feb 2010. They went on to hike three times in the next three months. The Feb statement said:

The Board considers it likely that monetary policy will, over time, need to be adjusted further in order to ensure that inflation remains consistent with the target over the medium term.

This wasnt exactly a smoking gun and traders should expect no more than this in todays decision. After the initial knee jerk move lower in AUD, this type of comment would cause a rebound higher in AUD, perhaps 50 pips.

A negative surprise that would compound AUD losses would be if the final line of the statement continued to read: the current mildly restrictive stance of monetary policy remained appropriate.

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