Forex trading guide: RBA's interest rate decision

Will the RBA cut its rates this week? Here’s a neat trading guide for forex traders who are looking to make some pips from the event.

 

Why should I trade this anyway?

Good question, my young padawan. Forex traders tend to listen to central banks like the Reserve Bank of Australia (RBA), mostly because they’re the big bosses of interest rates and local money supply.

Hints of easy policies usually mean that the economy is in trouble, at least enough to need some boosting (yikes!) or lower interest rates (double yikes!). Meanwhile, hints of hawkish policies could mean higher interests for holding local currencies (yay!) and that the economy is in good enough shape to reduce government stimulus (double yay!).

 

What did the RBA say last month?

As expected, Glenn Stevens and his gang kept their interest rates steady at 2.00%. In a near carbon copy of their previous decision, they’ve recognized that the Australian economy continues to rebalance after a boom in mining investment and that inflation is expected to remain low “over the next year or two.”

A few tweaks to the statement include nods to the recent increases in commodity prices (after years of declines) and improvement in global risk sentiment following months of heightened volatility.

What caught the Aussie bulls and bears’ attention was the RBA’s lack of jawboning. With AUD/USD around 300 pips higher from when they last published a decision, most players were expecting a bit of jawboning from Stevens. Instead of openly jawboning the Aussie though, the RBA only said that the currency’s recent appreciation “could complicate the adjustment under way in the economy.”

 

What are market players expecting this time?

As I mentioned in my Australian economy snapshot, the latest Australian CPI report increased speculations of an RBA rate cut. After all, the central bank did say that “continued low inflation would provide scope for easier policy.”

Right now market players are split on whether or not the RBA would cut its rates from 2.0% to 1.75%. On one hand inflation is well below the RBA’s 2%-3% target with Q1 2016 showing a 0.2% growth and the annualized figure coming in at 1.3%.

On the other hand another rate cut would further stoke Australia’s housing market, which is not a good deal given that household debt is already at record high levels. Improvements in the unemployment rate and business confidence are also expected to keep the RBA from pulling the trigger on a rate cut.

 

How might AUD/USD react?

Last month the Aussie got a boost from the RBA jawboning less than the markets had expected. AUD/USD had popped up for all of thirty minutes and proceeded to trade on the reigning risk-aversion theme for the rest of the day.

With an almost 50/50 call on the RBA’s decision, the Aussie’s reaction is likely to be more volatile than last month. A rate cut could drag AUD/USD below last week’s lows and even possibly break the uptrend that’s been valid since early March. If the RBA keeps its rates steady though, then the Aussie could get a little more boost across the board and challenge last week’s highs.

Last but not the least (and the most likely scenario) is that the RBA could keep its rates steady but jawbone a bit more aggressively to stem the Aussie’s gains. In this case, the Aussie’s direction and volatility would depend on the RBA’s message and its bias for future policy decisions.