Reserve Bank of Australia Preview: Will a 15 bps rate hike be enough to lift the aussie?

The Reserve Bank of Australia (RBA) is on course to deliver its first rate hike in 11 years, as it seeks to keep inflation in check, ignoring the upcoming federal election on May 21. The policy decision will be announced this Tuesday, May 3, at 0430 GMT.  Will the expected rate hike by the Australian central bank be able to save AUD bulls?

RBA can’t miss the inflation surge

The Australian central bank is widely expected to raise the Official Cash Rate (OCR) by 15 basis points (bps) to 0.25% from a record low of 0.10% at its May meeting.

So far, the RBA has been behind the curve, as most major central banks have embarked upon its tightening journey to combat raging inflation. With Australia’s annualized Q1 2022 Consumer Price Index (CPI) at a 20-year high of 5.1%, however, it has set a clear path for the central bank to kick off its rate hike cycle earlier than previously thought.

The latest Reuters poll of economists showed last week that a majority of them predicted the RBA to hike the key rate to 0.25% in May.

“Median forecasts showed the benchmark rate would rise to 1.00% by end-September and to 1.50% by year-end, double the 0.75% predicted in the previous survey,” per Reuters.

Last month, the RBA April meeting’s minutes revealed that a further increase in inflation is expected, while 'the evidence that inflation is sustainably within the 2-3% target range' is the prerequisite for an interest rate rise.

Ahead of the country’s quarterly inflation release, markets thought that the RBA might not act until the federal election, making the case for a June rate hike inevitable. But the uptick in inflation has compelled the central bank to take the lead from its global peers.

Although inflationary pressures are stemming from the external environment, in the face of the Russia-Ukraine war and China’s covid lockdowns affecting the global supply chain, the RBA has to act now to keep a check on higher inflation.

The economy remains in better shape to cope with higher borrowing costs, with a strong trade surplus and a tighter labor market. The RBA, however, needs to act with caution to avoid a hard landing, as the economy puts behind the post-pandemic recovery.

Trading AUD/USD on the RBA decision

AUD/USD remains heavily battered near four-month lows just above 0.7000, as the hawkish Fed expectations, China’s economic slowdown concerns and pre-RBA anxiety keep the AUD bulls at bay.

As mentioned above, a 15 bps rate hike is well priced-in by the market. Therefore, the aussie will need more than the given rate increase to stage any meaningful recovery beyond 0.7100. AUD bulls could receive the much-needed boost if the RBA front-loads rate hike prospects for this year, affirming markets’ expectations of 1.50% by end-2022.

Should the bank stand pat or refrain from committing any big plans, AUD/USD could take a massive hit, with a test of the January lows of 0.6965 on the table. The reaction in the AUD/USD pair could also be influenced by the risk tone prevalent at the time of the central bank decision.