Limited increase in the Australian rate, the Aussie dollar faces appreciation pressure

The RBA’s monetary policy decision on February 2nd has become a crucial momentum for the Australian dollar’s movement. The indicated rate hike in Australia provides limited room for currency appreciation, as the signals sent by the RBA will heavily influence market response. Analysis by Francesco Pesole, senior economist at ING Bank, highlights that the potential appreciation of the Australian dollar largely depends on how the central bank communicates this interest rate increase to the public.

RBA Policy Dilemma Amid Inflation Pressure

Inflation exceeding expectations in December and ongoing developments in the property market provide strong justification for the RBA to raise interest rates. Hotter-than-expected economic data create a necessity for the central bank to act. However, a dilemma arises when the RBA must consider the long-term impact of signals that may be perceived by the market as a new tightening cycle.

Pesole emphasizes in a report to Jin10 that the RBA should avoid giving the impression that this rate hike is the beginning of a series of continuous increases. The key question is how the central bank balances the need to combat inflation with concerns about constraining future monetary policy flexibility.

Market Expectations: Are Further Steps Ahead?

The market currently expects at least one more Australian rate hike before the end of the year. This prediction reflects the investment community’s confidence that inflation pressures require a more aggressive policy response. However, these expectations themselves pose a challenge for the RBA’s efforts to limit policy message volatility.

Limited Impact on Aussie Dollar Appreciation

Although, in principle, a rate hike should support the Australian dollar’s strength by attracting foreign investors, its effect will heavily depend on how the RBA frames its communication. If the RBA successfully conveys that this rate increase is an isolated action with specific context, rather than the start of a sustained tightening cycle, the positive impact on appreciation could be limited.

Conversely, if the market perceives signals indicating more hikes to come, initial reactions might be positive for the dollar. However, this could create expectations that are difficult to fulfill, with a risk of deeper corrections later on. Therefore, this tightrope walk suggests that the communication of Australian interest rate policy could be more important than the rate hikes themselves.