Australian Dollar weakens despite hawkish RBA; AUD/USD slips below 0.7150 on firmer USD

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AUD/USD attracts fresh sellers following the previous day’s bounce from over a two-week low.
Geopolitical uncertainties and rising Fed rate hike bets underpin the USD, weighing on the pair.
The RBA’s hawkish outlook fails to inspire the Aussie bulls or lend any support to spot prices.

The AUD/USD pair struggles to capitalize on the previous day's modest recovery from the 0.7120-0.7115 region, or over a two-week low, and meets with a fresh supply during the Asian session on Tuesday. The intraday slide is sponsored by the emergence of some US Dollar (USD) dip-buying, which overshadows the hawkish Reserve Bank of Australia (RBA) and drags spot prices back below mid-0.7100s in the last hour.

In fact, Minutes of the RBA's May policy meeting showed that eight of nine board members backed the rate hike to 4.35%, citing rising inflation risks from the Gulf conflict. Earlier, RBA Assistant Governor Sarah Hunter said that the central bank is worried higher energy costs will feed through to consumer prices quickly, potentially creating a ‌significant shift in inflation expectations. This reaffirms market expectations for a further rate hike at the August RBA meeting, though it does little to benefit the Aussie amid the underlying USD bullish sentiment.

Following the previous day's pullback from its highest level since April 7, the USD Index (DXY), which tracks the Greenback against a basket of currencies, regains positive traction amid a combination of supporting factors. Despite renewed optimism over a potential US-Iran peace deal, investors remain on edge amid broader disagreements over Tehran's nuclear program and the Strait of Hormuz. Apart from this, expectations that the US central bank will raise borrowing costs by the year-end revive the USD demand and weigh on the AUD/USD pair.

The market focus shifts to the release of FOMC Minutes on Wednesday. In the meantime, fresh developments surrounding the Middle East crisis could inject volatility in the markets. US President Donald Trump called off a planned military strike on Iran and said that there is a good chance an Iran nuclear deal can be reached. The muted reaction, however, points to the market skepticism over a quick resolution to the Iran conflict, which might continue to benefit the safe-haven USD and backs the case for a further depreciating move for the AUD/USD pair.

RBA FAQs

What is the Reserve Bank of Australia and how does it influence the Australian Dollar?

The Reserve Bank of Australia (RBA) sets interest rates and manages monetary policy for Australia. Decisions are made by a board of governors at 11 meetings a year and ad hoc emergency meetings as required. The RBA’s primary mandate is to maintain price stability, which means an inflation rate of 2-3%, but also “..to contribute to the stability of the currency, full employment, and the economic prosperity and welfare of the Australian people.” Its main tool for achieving this is by raising or lowering interest rates. Relatively high interest rates will strengthen the Australian Dollar (AUD) and vice versa. Other RBA tools include quantitative easing and tightening.

How does inflation data impact the value of the Australian Dollar?

While inflation had always traditionally been thought of as a negative factor for currencies since it lowers the value of money in general, the opposite has actually been the case in modern times with the relaxation of cross-border capital controls. Moderately higher inflation now tends to lead central banks to put up their interest rates, which in turn has the effect of attracting more capital inflows from global investors seeking a lucrative place to keep their money. This increases demand for the local currency, which in the case of Australia is the Aussie Dollar.

How does economic data influence the value of the Australian Dollar?

Macroeconomic data gauges the health of an economy and can have an impact on the value of its currency. Investors prefer to invest their capital in economies that are safe and growing rather than precarious and shrinking. Greater capital inflows increase the aggregate demand and value of the domestic currency. Classic indicators, such as GDP, Manufacturing and Services PMIs, employment, and consumer sentiment surveys can influence AUD. A strong economy may encourage the Reserve Bank of Australia to put up interest rates, also supporting AUD.

What is Quantitative Easing (QE) and how does it affect the Australian Dollar?

Quantitative Easing (QE) is a tool used in extreme situations when lowering interest rates is not enough to restore the flow of credit in the economy. QE is the process by which the Reserve Bank of Australia (RBA) prints Australian Dollars (AUD) for the purpose of buying assets – usually government or corporate bonds – from financial institutions, thereby providing them with much-needed liquidity. QE usually results in a weaker AUD.

What is Quantitative tightening (QT) and how does it affect the Australian Dollar?

Quantitative tightening (QT) is the reverse of QE. It is undertaken after QE when an economic recovery is underway and inflation starts rising. Whilst in QE the Reserve Bank of Australia (RBA) purchases government and corporate bonds from financial institutions to provide them with liquidity, in QT the RBA stops buying more assets, and stops reinvesting the principal maturing on the bonds it already holds. It would be positive (or bullish) for the Australian Dollar.