Key Moments
- AUD/USD traded around 0.7060 and extended its decline for a third straight session during Asian trading on Friday.
- RBA Assistant Governor Chris Kent indicated that earlier rate hikes are working but warned that additional tightening remains an option if new inflation risks arise.
- Softer U.S. PPI data reduced the implied probability of a September Federal Reserve rate increase to 34.8%.
RBA Signals Conditional Scope for Further Tightening
AUD/USD edged lower for a third consecutive day, hovering near 0.7060 in Asian trade on Friday. The move came despite commentary from Reserve Bank of Australia (RBA) Assistant Governor Chris Kent, who on Thursday emphasized that the central bank’s recent rate increases are having the desired effect on the economy. At the same time, he stressed that further hikes remain a possibility if new inflation-related risks arise.
RBA Tightening Filters Through the Real Economy
Analysts at BNY Mellon highlighted that the impact of the RBA’s earlier policy tightening is now clearly visible in real economic activity. They noted that
“higher borrowing costs, rising mortgage payments, weaker established housing market conditions and a stronger Australian dollar have all tightened financial conditions, while aggregate demand is slowing as intended to help return inflation to target.”
This backdrop of cooling housing activity and a firmer currency is being interpreted as evidence that policy settings have shifted toward a more restrictive stance that is helping guide inflation back toward the RBA’s target range.
While the Australian Dollar (AUD) faces headwinds from a relatively tight domestic policy environment and signs of slower demand, downside in AUD/USD may be cushioned by recent weakness in the U.S. Dollar (USD) following softer-than-expected U.S. inflation data. Market participants are now looking ahead to U.S. July Retail Sales, due later on Friday, for additional direction.
U.S. PPI Undershoots Expectations and Eases Fed Hike Bets
The inflation backdrop in the United States added another layer to the FX picture. Data from the Bureau of Labor Statistics (BLS) showed that U.S. wholesale prices for goods and services were unchanged in July, defying expectations for a 0.2% rise and following a revised 0.1% decline in June. Excluding food and energy, core Producer Price Index (PPI) advanced 0.2%, slightly below the consensus estimate of 0.3%.
On a year-over-year basis, headline PPI increased 4.7% in July, while core PPI rose 4.2%. These softer inflation readings have tempered expectations for further Federal Reserve tightening. According to the CME FedWatch Tool, the implied probability of a U.S. rate hike at the upcoming September meeting declined to 34.8%, compared with 40% immediately after the PPI release.
| Indicator | Latest Reading | Expectation / Prior |
|---|---|---|
| Headline PPI (month-on-month, July) | 0.0% | 0.2% expected; 0.1% decline in June (revised) |
| Core PPI (month-on-month, July) | 0.2% | 0.3% expected |
| Headline PPI (year-on-year, July) | 4.7% | Not stated |
| Core PPI (year-on-year, July) | 4.2% | Not stated |
| Implied probability of September Fed hike | 34.8% | 40% immediately after PPI release |
Australian Dollar: Structural Drivers and Macro Sensitivities
The Australian Dollar (AUD) is heavily influenced by the level of interest rates set by the RBA. As Australia is rich in natural resources, the price of its key export, Iron Ore, is another major driver. Additional important factors include the performance of the Chinese economy, inflation dynamics in Australia, domestic growth trends, and the country’s Trade Balance. Broader market sentiment also plays a role: risk-on conditions tend to support the AUD, while risk-off episodes typically weigh on the currency.
RBA Policy Transmission to the Currency
The RBA shapes the value of the AUD primarily through its setting of benchmark interest rates, which determine the cost at which Australian banks lend to one another and influence borrowing conditions across the economy. The central bank aims to keep inflation within a 2-3% range by adjusting rates higher or lower. Comparatively higher rates than those of other major central banks generally underpin the AUD, while relatively lower rates tend to be negative for the currency. In addition, the RBA can deploy quantitative easing or quantitative tightening to alter credit conditions, with the former usually AUD-negative and the latter AUD-positive.
Exposure to Chinese Growth and Iron Ore Prices
China’s role as Australia’s largest trading partner means that shifts in Chinese economic performance can have a direct impact on the AUD. Stronger Chinese growth typically leads to greater demand for Australian raw materials, goods, and services, lifting AUD demand. Conversely, slower-than-expected Chinese growth can dampen demand and weigh on the currency. Surprises – either positive or negative – in Chinese data frequently translate into noticeable moves in AUD pairs.
Iron Ore, Australia’s largest export and primarily shipped to China, is another crucial variable for the currency. Rising Iron Ore prices tend to support the AUD as they boost aggregate demand for Australian exports and can improve Australia’s Trade Balance. Falling prices generally have the opposite effect and can be a headwind for the currency.
Trade Balance and Its Influence on AUD
Australia’s Trade Balance – the difference between export revenues and import expenditures – is also a key determinant of AUD performance. A positive Trade Balance, driven by strong foreign demand for Australian exports, tends to strengthen the currency because of the net demand created by overseas buyers. A negative Trade Balance, by contrast, can put pressure on the AUD.
TradingPedia.com is a financial media specialized in providing daily news and education covering Forex, equities and commodities. Our academies for traders cover 
