Australian Dollar weakens despite RBA cautious outlook

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AUD/USD extends its losses for the second successive session, trading around 0.7110 during the Asian hours on Friday. However, the downside of the pair could be limited as the Australian Dollar (AUD) may strengthen on cautious sentiment surrounding the Reserve Bank of Australia (RBA) policy outlook.

AUD/USD may regain ground as the RBA is expected to leave the cash rate unchanged at 3.85% in March.
Australia’s hotter January inflation boosts expectations of an RBA rate hike in May.
Traders await January PPI data for fresh signals on Federal Reserve policy direction.

Traders widely expect the RBA to leave the cash rate unchanged at 3.85% at its March meeting, as policymakers will not receive the full Q1 inflation report until late April. RBA Governor Michele Bullock also emphasized that a patient approach remains appropriate with the economy operating near equilibrium, dampening expectations of an aggressive tightening cycle.

Australia’s hotter-than-expected January inflation reading has strengthened expectations that the RBA could deliver another rate hike in May. Markets are pricing in roughly 40 basis points of additional tightening this year, although many analysts believe the terminal rate will peak near 4.10%, close to the high reached during the post-pandemic inflation surge.

Meanwhile, the AUD/USD pair could find support as the US Dollar (USD) struggles amid ongoing uncertainty surrounding US trade policy. Traders are looking ahead to the release of the US January Producer Price Index (PPI) later on Friday for fresh Federal Reserve (Fed) direction.

US President Donald Trump announced plans to impose a blanket 15% tariff on imports following a Supreme Court decision that invalidated his earlier reciprocal tariff framework. However, US Trade Representative Jamieson Greer indicated that tariffs could be lifted to 15% or higher for several countries in the coming days.

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.