RBA holds interest rate at 4.10%, flags need for more rate hikes

The Reserve Bank of Australia (RBA) board members decided to make no changes to the Official Cash Rate (OCR), leaving it at 4.10% at its August monetary policy meeting.

Here are the key highlights from the RBA’s August monetary policy statement, as presented by Governor Phillip Lowe.

The decision to hold rates unchanged provides further time to assess the impact of the increase in interest rates to date and the economic outlook.

Inflation in Australia is declining but is still too high.

Household consumption growth is weak.

Conditions in the labour market remain very tight, although they have eased a little.

Returning inflation to target within a reasonable timeframe remains the priority.

Recent data are consistent with inflation returning to the 2–3% target range over the forecast horizon.

The outlook for household consumption is an ongoing source of uncertainty.

Some further tightening of monetary policy may be required to ensure that inflation returns to target in a reasonable timeframe, but that will depend upon the data and the evolving assessment of risks.

AUD/USD reaction

In a knee-jerk reaction to the RBA decision, the AUD/USD pair dropped over 40 pips to test 0.6660. The pair is down 0.70% on the day.

AUD/USD: 15-minutes chart

Interest rates FAQs

What are interest rates?

Interest rates are charged by financial institutions on loans to borrowers and are paid as interest to savers and depositors. They are influenced by base lending rates, which are set by central banks in response to changes in the economy. Central banks normally have a mandate to ensure price stability, which in most cases means targeting a core inflation rate of around 2%.
If inflation falls below target the central bank may cut base lending rates, with a view to stimulating lending and boosting the economy. If inflation rises substantially above 2% it normally results in the central bank raising base lending rates in an attempt to lower inflation.

How do interest rates impact currencies?

Higher interest rates generally help strengthen a country’s currency as they make it a more attractive place for global investors to park their money.

How do interest rates influence the price of Gold?

Higher interest rates overall weigh on the price of Gold because they increase the opportunity cost of holding Gold instead of investing in an interest-bearing asset or placing cash in the bank.
If interest rates are high that usually pushes up the price of the US Dollar (USD), and since Gold is priced in Dollars, this has the effect of lowering the price of Gold.

What is the Fed Funds rate?

The Fed funds rate is the overnight rate at which US banks lend to each other. It is the oft-quoted headline rate set by the Federal Reserve at its FOMC meetings. It is set as a range, for example 4.75%-5.00%, though the upper limit (in that case 5.00%) is the quoted figure.
Market expectations for future Fed funds rate are tracked by the CME FedWatch tool, which shapes how many financial markets behave in anticipation of future Federal Reserve monetary policy decisions.

This section below was published at 01:30 GMT as a preview of the Reserve Bank of Australia (RBA) policy announcements.

Interest rate in Australia is expected to rise by 25 bps to 4.35% in August.
Reserve Bank of Australia could surprise for the fourth straight meeting.
RBA policy decision and guidance to rock the Australian Dollar.

With the US Federal Reserve (Fed) and the European Central Bank (ECB) probably nearing the end of their tightening cycles, all eyes remain on the Reserve Bank of Australia (RBA) interest rate decision due to be announced this Tuesday.

The RBA is stuck between a rock and a hard place, as Australia’s labor market remains very tight while the country’s battle with inflation is finally showing results. The housing market is also on a notable recovery path, making Tuesday’s decision a close call for the central bank.

Reserve Bank of Australia interest rate decision: All you need to know on Tuesday, August 1

AUD/USD is consolidating gains near 0.6700, despite a broad rebound in the US Dollar, as the Australian Dollar capitalizes on China’s stimulus optimism.
US S&P 500 futures post small gains, helped by risk flows while the benchmark 10-year US Treasury bond yield stays shy of the 4.0% level.
China's Caixin Manufacturing Purchasing Managers' Index (PMI) returned to contraction, coming in at 49.2 in July as against the 50.5 reading registered in June, the latest data showed on Tuesday.
On Monday, China’s official Manufacturing and Non-Manufacturing PMIs for July came in mixed and reinforced expectations of further stimulus by the Chinese authorities to stimulate economic recovery.
China’s National Bureau of Statistics (NBS) showed that the Manufacturing PMI rose to 49.3 from 49.0 in June vs. a forecast of 49.2. China’s Non-Manufacturing PMI dropped to 51.5 in the reported, compared with 53.2 seen in June.
Last week, the Federal Reserve raised rates by the widely expected 25 basis points (bps) to a 22-year high of 5.25%-5.50% and left doors open for more tightening without committing to the timing of the next lift-off.
Powell refrained from providing any forward guidance, emphasizing a ‘data-dependent’ and ‘meeting-by-meeting’ approach.
The RBA event will likely provide near-term direction in the AUD/USD pair heading into Friday’s all-important US employment data. The Australian central bank will publish its Statement on Monetary Policy Friday, including the updated macro forecasts.

RBA interest rates expectations: How will it impact AUD/USD?

The Reserve Bank of Australia is seen raising the Official Cash Rate by 25 basis points (bps) from 4.10% to 4.35% following its August monetary policy meeting scheduled this Tuesday, with the policy announcement due at 04:30 GMT.

Speaking on "The Reserve Bank Review and Monetary Policy" at the Economic Society of Australia Business Lunch right after the July policy meeting, Reserve Bank of Australia (RBA) Governor Philip Lowe said, “Some further tightening of monetary policy may be required to ensure that inflation returns to target in a reasonable timeframe, but that will depend upon how the economy and inflation evolve.”

Since then, Australian data has come in mixed, with inflation slowing down while the labor and housing market continue to show robustness. Australia’s Consumer Prices Index (CPI) rose 0.8% in the June quarter, under forecasts of 1.0% and the smallest gain since the third quarter of 2021. The annual pace in core inflation slowed to 6.0%, from 6.6%. Meanwhile, the Unemployment Rate dropped to a fresh five-decade low of 3.5% in June and the number of employed people in Australia rose by 32.6K in June as compared to consensus estimates of 15K.

Markets brace for fireworks as the Bank has a tendency to offer surprises. In three of its last four policy announcements, the RBA has taken markets off guard. At its July meeting, the central bank unexpectedly kept rates steady at 4.10% after delivering two consecutive hawkish surprises by going for 25 bps rate hikes in May and June.

The Australian Dollar is poised for massive volatility on the RBA decision due to the wide divergence between market pricing and economists' expectations, which leaves room for yet another surprise. According to Refinitiv's RBAWATCH, markets see only a 22% probability of a quarter percentage point RBA hike in August but the latest Reuters poll showed a slight majority leaning in favor of such a rate increase.

Economists at Standard Chartered offered a sneak peek at what they expect from the RBA policy decision, stating that “we now expect the Reserve Bank of Australia (RBA) to hike further by a total of 50bps in the rest of this year. The latest Q2 CPI readings offer some room for the RBA to wait and see, in our view. We therefore now expect the central bank to hike by 25bps each in September and November; we had previously expected it to hike in August and September by the same amount.”

Meanwhile, Dhwani Mehta, Asian Session Lead Analyst at FXStreet, notes key technicals to trade AUD/USD on the policy outcome. “AUD/USD has regained the critical resistance near 0.6700 in the lead-up to the RBA showdown. That level is the confluence of the horizontal 50 and 100-Daily Moving Averages (DMA). The 14-day Relative Strength Index (RSI), however, is sitting beneath the 50 level, keeping the bearish potential intact for Aussie sellers.”

“The next powerful upside barrier for AUD/USD is aligned at 0.6735, where the 21 and 200 DMAs coincide. A sustained break above the latter will trigger a fresh upswing toward 0.6800 and beyond. Conversely, failure to defend the two-week low of 0.6622 could reinforce selling interest, with a sell-off toward the 0.6550 psychological support inevitable,” Dhwani added.

Central banks FAQs

What does a central bank do?

Central Banks have a key mandate which is making sure that there is price stability in a country or region. Economies are constantly facing inflation or deflation when prices for certain goods and services are fluctuating. Constant rising prices for the same goods means inflation, constant lowered prices for the same goods means deflation. It is the task of the central bank to keep the demand in line by tweaking its policy rate. For the biggest central banks like the US Federal Reserve (Fed), the European Central Bank (ECB) or the Bank of England (BoE), the mandate is to keep inflation close to 2%.

What does a central bank do when inflation undershoots or overshoots its projected target?

A central bank has one important tool at its disposal to get inflation higher or lower, and that is by tweaking its benchmark policy rate, commonly known as interest rate. On pre-communicated moments, the central bank will issue a statement with its policy rate and provide additional reasoning on why it is either remaining or changing (cutting or hiking) it. Local banks will adjust their savings and lending rates accordingly, which in turn will make it either harder or easier for people to earn on their savings or for companies to take out loans and make investments in their businesses. When the central bank hikes interest rates substantially, this is called monetary tightening. When it is cutting its benchmark rate, it is called monetary easing.

Who decides on monetary policy and interest rates?

A central bank is often politically independent. Members of the central bank policy board are passing through a series of panels and hearings before being appointed to a policy board seat. Each member in that board often has a certain conviction on how the central bank should control inflation and the subsequent monetary policy. Members that want a very loose monetary policy, with low rates and cheap lending, to boost the economy substantially while being content to see inflation slightly above 2%, are called ‘doves’. Members that rather want to see higher rates to reward savings and want to keep a lit on inflation at all time are called ‘hawks’ and will not rest until inflation is at or just below 2%.

Is there a president or head of a central bank?

Normally, there is a chairman or president who leads each meeting, needs to create a consensus between the hawks or doves and has his or her final say when it would come down to a vote split to avoid a 50-50 tie on whether the current policy should be adjusted. The chairman will deliver speeches which often can be followed live, where the current monetary stance and outlook is being communicated. A central bank will try to push forward its monetary policy without triggering violent swings in rates, equities, or its currency. All members of the central bank will channel their stance toward the markets in advance of a policy meeting event. A few days before a policy meeting takes place until the new policy has been communicated, members are forbidden to talk publicly. This is called the blackout period.

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RBA leaves interest rate unchanged at 4.10% in August

AUD/USD reaction