Reserve Bank of Australia Preview: AUD/USD ready for another hike?

• The Reserve Bank of Australia will announce its decision on interest rates on Tuesday.
• Market expectations differ on whether the bank will keep interest rates unchanged or implement a 25 basis point rate hike.
• Odds of a hike rose following the latest Australian Consumer Price Index report.
• The AUD/USD has rebounded sharply, improving the near term outlook.

The Reserve Bank of Australia (RBA) is set to announce its monetary policy decision on Tuesday, June 6 at 04:30 GMT. The market consensus is for the central bank to keep its monetary policy unchanged.

At the last meeting, the RBA caught markets off guard by raising the key interest rate by 25 basis points to 3.85%. Members considered holding rates unchanged or implementing the 25 bps increase. "In weighing up the two options, members recognised that the arguments were finely balanced but judged it was appropriate to increase interest rates at this meeting," the RBA said. They also mentioned that "further increases in interest rates may still be required, but that this would depend on how the economy and inflation evolve."

Since the May meeting, Australian data has been mixed. The jobless rate rose slightly in April, while the May PMI reflected some softening in economic activity, particularly in the manufacturing sector. This context would warrant a pause. However, the Monthly Consumer Price Index in April showed an acceleration from 6.3% to 6.8%, putting a rate hike back on the table. It was the first acceleration in the CPI since December, moving away from the 2-3% target.

"We're in a very data-dependent mode," said RBA Governor Philip Lowe. He explained that they have increased interest rates "a lot" and that monetary policy "is restrictive and it's working." Despite most expectations for a pause, markets do not see the end of the tightening cycle. The cash rate is expected to peak above 4%.

Could AUD/USD suffer if RBA holds steady?

The AUD/USD has rebounded sharply, recovering from six-month lows near 0.6450 to around 0.6650, driven mostly by a weaker US dollar and an improvement in risk sentiment.

At present, risk flows seem to be the key driver for the AUD/USD. The pair did not react much to the higher-than-expected Australian CPI reading, indicating that other factors, such as global risk sentiment, are more significant. Easing from the People's Bank of China could potentially have a greater impact on the AUD/USD than a rate hike from the RBA.

Whatever decision the RBA takes, it is likely to keep the doors open to another rate hike. If it decides to pause, this would be considered a "hawkish hold". If the RBA increases the cash rate, it is unlikely to be a "dovish hike". While the AUD/USD could benefit from a rate hike, it is not necessarily a sustainable move. The upcoming Australian Q1 GDP report, due on Wednesday, will be an important factor to watch.

The daily chart shows the AUD/USD is currently moving upwards, recovering from a decline that occurred in May. If it remains above 0.6600, the Aussie may continue to gain ground, with the next resistance levels at 0.6680 and 0.6710. On the flip side, the AUD/USD still has room to correct lower to 0.6550. A break below 0.6550 would increase bearish pressure and expose the 0.6500 area, which represents the last line of defense before fresh cycle lows.

AUD/USD daily chart