Reserve Bank of Australia Preview: Will a 50 bps rate hike rescue AUD bulls?

• Reserve Bank of Australia is set to hike OCR by another 50 bps to 1.35% in July.
• Australia’s Inflation expectations surged to 6.7% in June, economy holds strong.
• Limited scope for AUD/USD to recover, as a double-dose rate hike fully baked in.

The Reserve Bank of Australia (RBA) is widely expected to deliver a rate hike at its third straight monetary policy meeting when it meets on July 5. The central bank follows the footsteps of the US Federal Reserve (Fed) in fighting inflation amid a resilient economy. The central bank will announce the policy decision at 0430 GMT.

Strong response to higher inflation inevitable

Even though the RBA remains divided on whether to hike the Official Cash Rate (OCR) by 25 bps or 50 bps at its July policy meeting, the market has already priced in a double-dose lift-off. After a surprise 50 bps rate hike in June, the RBA will likely announce another 50 bps rate increase to 1.35% vs. June’s 0.85%. In May, the central bank raised the key rate by 0.25% for the first time in over a decade.

The aussie central bank remains committed to fighting inflation head-on, against a backdrop of a tighter labor market and strong household spending. The Australian Unemployment Rate steadied at a five-decade low of 3.9% in June while Retail sales rose 0.9% in May, the fifth straight month of growth and double the market forecasts of a 0.4% increase. Meanwhile, the RBA’s widely watched gauge, the wage price index, rose in the quarter ending March at the fastest pace since the end of 2018, at a 2.4% annual pace.

The main catalyst for a bigger rate hike, however, remains in rising inflation expectations. Expectations of price increases in Australia increased to 6.7% in June from 5% in May of 2022, according to the latest data published by the Melbourne Institute. After the RBA upgraded its inflation forecast to reach 7% by the end of 2022, markets are predicting that the bank will have to raise rates faster, to near 3% by the end of the year.

Last month, RBA Governor Philip Lowe warned, “ongoing wage growth in a 4 to 5 % range would make it harder to get inflation down,” adding that “high inflation is cutting into people's real incomes.” Lowe’s urgency for inflation control before it gets out of hand makes it a straight case for a 50 bps rate rise while a super-sized 75 bps hike is not on the table, for now.

China’s re-opening from covid lockdowns accompanied by a recovery in the country’s business activity helps underpin the Australian economy, offering the much-needed cushion to the RBA if it needs to act tougher on combating inflation.

Trading AUD/USD with the RBA

AUD/USD is lurking around the lowest levels in two years clocked near 0.6750 last Friday. With looming recession risks and an aggressive Fed tightening outlook, the US dollar remains broadly favored. This is likely to keep the aussie pressured to the downside heading into the RBA announcement.

AUD/USD: Daily chart

A fully baked-in 50 bps rate hike is unlikely to inspire AUD bulls, as any meaningful recovery in AUD/USD will gain acceptance only on a sustained move above the rising trendline support-turned-resistance at 0.6862. The 14-day Relative Strength Index (RSI) is seeing a minor pullback from lower levels but still remains deep in the bearish territory.

Should the RBA’s policy guidance hint at chances of a 50 bps rate hike yet again in August, the pair could take out the latter decisively on its way towards the 0.6920 strong resistance, eventually targeting 0.7000.

On the other hand, a downside surprise of a 25 bps lift-off or any hesitance by the RBA, with regards to its future tightening path, could reinforce the selling interest and fuel a fresh downswing towards 0.6600.