Australian Dollar declines despite RBA rate hike warnings

RBA Assistant Governor Sarah Hunter warned interest rates may rise further due to persistent inflation.
CME FedWatch Tool suggests that markets price in a 90.6% chance the Fed holds rates steady in October.
Traders monitor Middle East developments, including US-Iran tensions and Houthi attacks in Saudi Arabia.

AUD/USD depreciates after posting modest gains in the previous trading day, trading around 0.7030 during Asian hours on Monday. However, the downside of the currency pair could be restrained as the Australian Dollar (AUD) may receive support following warnings from Reserve Bank of Australia (RBA) Assistant Governor Sarah Hunter.

TMGM Analysis: Financial Market News, Economic Calendar & Market Insights

Speaking on Sunday, Hunter cautioned that interest rates may need to rise further due to stubborn inflation and the risk of overseas price pressures becoming entrenched in the economy. Her remarks reinforced expectations of a restrictive monetary stance following four rate hikes earlier this year.

Market focus now shifts to September inflation data scheduled for release later this week, especially after August CPI figures remained above the RBA's target range of 2% to 3%. Furthermore, any renewed escalation in the US-Iran conflict that drives up crude oil prices would deepen the RBA’s concerns regarding second-round inflation effects, increasing the likelihood of further policy tightening beyond November.

RBA faces credibility test as inflation expectations drift above target

Commerzbank’s Norman Liebke flags a worrying shift in domestic inflation psychology, noting that survey evidence now shows “a growing share of businesses believe that inflation of 3-3.5% is ‘the new normal’.” He argues that this is problematic for the RBA’s inflation-targeting framework, given the “long-term inflation target of 2-3%,” and underscores that the risk is not merely theoretical: “trimmed-mean inflation most recently stood at 3.6%, further above the target range.” In his view, this combination of elevated core inflation and drifting expectations reinforces the challenge facing policymakers as markets increasingly price in the prospect of further RBA tightening.

Traders have also turned their attention to the upcoming Federal Reserve policy decision. The Fed is widely expected to hold interest rates steady before potentially pursuing another rate hike in December. According to the CME FedWatch Tool, markets are currently pricing in a 90.6% probability of a rate pause at the October 27–28 policy meeting, alongside a 79.7% chance of a hike in December.

Meanwhile, market participants continue to monitor ongoing geopolitical developments in the Middle East. US President Donald Trump ruled out immediate military action against Iran, stating, “there will not be a strike today,” according to Al Jazeera. This followed earlier remarks where Trump suggested Washington might need to “finish the job” or potentially reach a deal with Tehran amidst growing Iranian and Houthi threats against American interests in the region.

Adding to regional tensions, Yemen's Houthis declared on Sunday that they will continue targeting Saudi Arabia's King Khalid Airport in Riyadh, as reported by Reuters. This announcement came just hours after Saudi officials stated that airport flights had resumed despite repeated attacks by the group.

Australian Dollar FAQs

What key factors drive the Australian Dollar?

One of the most significant factors for the Australian Dollar (AUD) is the level of interest rates set by the Reserve Bank of Australia (RBA). Because Australia is a resource-rich country another key driver is the price of its biggest export, Iron Ore. The health of the Chinese economy, its largest trading partner, is a factor, as well as inflation in Australia, its growth rate and Trade Balance. Market sentiment – whether investors are taking on more risky assets (risk-on) or seeking safe-havens (risk-off) – is also a factor, with risk-on positive for AUD.

How do the decisions of the Reserve Bank of Australia impact the Australian Dollar?

The Reserve Bank of Australia (RBA) influences the Australian Dollar (AUD) by setting the level of interest rates that Australian banks can lend to each other. This influences the level of interest rates in the economy as a whole. The main goal of the RBA is to maintain a stable inflation rate of 2-3% by adjusting interest rates up or down. Relatively high interest rates compared to other major central banks support the AUD, and the opposite for relatively low. The RBA can also use quantitative easing and tightening to influence credit conditions, with the former AUD-negative and the latter AUD-positive.

How does the health of the Chinese Economy impact the Australian Dollar?

China is Australia’s largest trading partner so the health of the Chinese economy is a major influence on the value of the Australian Dollar (AUD). When the Chinese economy is doing well it purchases more raw materials, goods and services from Australia, lifting demand for the AUD, and pushing up its value. The opposite is the case when the Chinese economy is not growing as fast as expected. Positive or negative surprises in Chinese growth data, therefore, often have a direct impact on the Australian Dollar and its pairs.

How does the price of Iron Ore impact the Australian Dollar?

Iron Ore is Australia’s largest export, accounting for $118 billion a year according to data from 2021, with China as its primary destination. The price of Iron Ore, therefore, can be a driver of the Australian Dollar. Generally, if the price of Iron Ore rises, AUD also goes up, as aggregate demand for the currency increases. The opposite is the case if the price of Iron Ore falls. Higher Iron Ore prices also tend to result in a greater likelihood of a positive Trade Balance for Australia, which is also positive of the AUD.

How does the Trade Balance impact the Australian Dollar?

The Trade Balance, which is the difference between what a country earns from its exports versus what it pays for its imports, is another factor that can influence the value of the Australian Dollar. If Australia produces highly sought after exports, then its currency will gain in value purely from the surplus demand created from foreign buyers seeking to purchase its exports versus what it spends to purchase imports. Therefore, a positive net Trade Balance strengthens the AUD, with the opposite effect if the Trade Balance is negative.