- Reserve Bank of Australia could raise rates on Tuesday
- China’s trade and inflation statistics also in focus
- UK economy likely contracted in Q3 – can sterling hold up?
RBA decision will be difficult
With most major central bank decisions in the rearview mirror and volatility in bond markets easing, a quieter week lies ahead for currency traders. Most attention will focus on the Reserve Bank of Australia’s rate decision on Tuesday, with markets assigning a 60% probability of a rate hike.
Recent developments in Australia certainly favor another rate hike. Last week, the RBA governor stressed that her central bank will not hesitate to raise rates further. “if there is a substantial upward revision of the inflation outlook”. Immediately following these comments, third quarter inflation data surprised to the upside.
Likewise, home prices continue to rise and nearly hit an all-time high in October, according to CoreLogic. That can also drive inflation, both by raising rental prices and through the wealth effect, as higher home prices often translate into higher household spending.
Even the IMF recently warned that the RBA needs to raise rates further. to cool an economy that is operating beyond full capacity, with a historically booming labor market and population growth reinforcing the risk that inflation will remain high for some time.
Of course, not everything is rosy. For example, the latest round of business surveys signaled that economic growth will likely slow heading into the end of the year amid a decline in new orders. Likewise, the conflict in the Middle East generates uncertainty.
Most importantly, the global wave of rising bond yields has spread to Australia. With Australian yields trading near their highest levels in a decade, the bond market has essentially tightened the RBA too much, reducing the need for further rate hikes.
Therefore, there are strong arguments for both raising rates and keeping them unchanged. That said, the case for a rate hike appears stronger based on data and RBA commentary. Given that market prices only imply a 60% chance of a hike, a decision to raise rates could help boost the Australian dollar.
Beyond the RBA’s decision, the long-term path of the Australian dollar will also depend on global risk sentiment and any developments in China.
China awaits data on trade and inflation
The Australian currency is sensitive to news from China due to the close trade relationship between the two nations. Australia and New Zealand depend on Chinese demand to absorb their raw material exports, so the outlook for China directly influences the growth prospects of these economies.
This correlation helps explain why both currencies have been hammered this year, amid an unfolding housing crisis and a severe manufacturing slowdown in China. Investors have been waiting with bated breath for Beijing to roll out further stimulus measures, but so far the policy response has been disappointing.
China’s central government announced last week that it would increase its budget deficit, approving 1 trillion yuan ($137 billion) in debt issuances. This was a sign that fiscal spending is coming. However, this support package only represents 0.8% of GDP, so it may lack the “firepower” to truly revive the stagnant economy.
In this sense, the next launches will be closely followed by investors. Trade data for October will hit markets on Tuesday, ahead of inflation statistics for the same month on Thursday. All of these numbers are important, but markets often focus on exports and producer prices, which are considered indicators of global factory demand.
Aside from commodity-linked currencies, these releases could also affect global risk sentiment, consequently boosting stock markets in Asia and other regions.
UK GDP could be ugly
As for the UK, the highlights will come on Friday in the form of quarterly GDP figures. The British economy most likely contracted in the third quarter, something reflected in the monthly GDP readings already published and the gloomy business surveys.
Even more worrying is that the UK economy is suffering job losses. The labor market began losing jobs in June and this pattern continued into September. Faced with weaker demand conditions and shrinking margins, UK businesses are struggling to cut costs. One option is to lay off workers.
Job loss is how every recession starts, so this is a huge red flag. In turn, the outlook for sterling appears bleak. Economic growth is recovering while inflation continues to smolder, painting a stagflationary picture of the UK economy.
On top of that, Cable continues to show a strong correlation with stock markets, leaving it vulnerable should stocks decline again as the global economy loses power.
Finally, in the euro area, the latest producer price data will be released on Tuesday, ahead of retail sales on Wednesday.