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Upbeat RBA Could Lift Aussie, But All Eyes on Stocks

The Reserve Bank of Australia (RBA) will wrap up its latest meeting at 03:30 GMT Tuesday. No policy changes are on the menu, so any reaction in the aussie will come down to the signals in the accompanying statement and Governor Lowe’s tone. The economy has performed much better than the RBA expected, so a more optimistic view may be warranted, which could briefly boost the aussie. However, the overall trend will depend on whether the latest stock market correction continues.

RBA faces tough balancing act

Australia’s central bank will have a tough balancing act on its hands this week. It will have to justify why it needs to keep its foot heavy on the monetary gas, even though the economy has performed way better than anticipated.

The recovery in the jobs market has been remarkable. In its most recent forecasts, the RBA expected the unemployment rate to close the year at 8%, but instead unemployment was only at 6.8% in December. Similarly, policymakers expected annual inflation at a depressed 0.5% in Q4, while the actual number was 0.9%.

Furthermore, the latest PMI surveys paint a solid picture for economic growth, commodity prices remain elevated, domestic virus numbers are extremely low, and vaccines are being distributed across the globe.

Can’t sound too happy

Of course, it is far too early for the RBA to declare victory, as several downside risks remain in play. For instance, how much damage will the labor market take when the government’s JobSeeker program is scaled back in April? And what happens to the global outlook if one of the mutated covid-19 variants turns out to be resistant to the vaccines?

There’s also the ‘mini trade war’ with China to consider. China is Australia’s biggest customer for its commodity products, and in recent months Beijing has been imposing tariffs on some Australian exports. This confrontation has been limited to only a handful of items so far, which is why the aussie hasn’t reacted, but the RBA will be conscious of the risk of further escalation.

Beyond all these, the RBA also wants a weaker currency. Keeping a lid on the aussie was the main reason it cut rates back in November, and the currency has gained dramatically since then because of the vaccines. A stronger currency can dampen growth and inflation, so the last thing the RBA wants is to propel it even higher by sounding too optimistic.

Bearing everything in mind, policymakers will likely stick to a dovish message, while acknowledging the clear improvement in the economy – perhaps by upgrading their economic forecasts. That could boost the aussie, but only slightly, as the Bank will be conscious of not appearing too cheerful.

Aussie is all about risk sentiment

In the bigger picture, the aussie’s fate hangs mostly on how global risk sentiment fares. Specifically, will the latest retreat in stock markets continue, or has it already run its course?

Admittedly, the elements that drove equity markets to record highs and stratospheric valuations are still in play. Vaccines are being rolled out, central banks are all-in, and America is about to go on a federal spending spree, so this correction could be short lived.

Unless a vaccine-resistant mutation of the coronavirus is discovered, the overall outlook for stocks – and by extension for the aussie – remains favorable.

Taking a technical look at aussie/dollar, a bullish wave could encounter resistance near 0.7700, a region fortified by the 50- and 200-period moving averages on the four-hour chart. An upside break would turn the focus to the 0.7780 area next.

On the downside, another retreat could stall around the 0.7600 support handle initially, before the 0.7555 zone comes into view.

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