Could the Reserve Bank of Australia Really Raise Interest Rates? (page 1 of 2)

DailyFX Fundamentals 02-04-08

By Kathy Lien, Chief Strategist of DailyFX.com

- US Dollar: Time to See How the Outlook Stacks Up
- Could the Reserve Bank of Australia Really Raise Interest Rates?
- Euro: Inside Day Signals a Potential Break

US Dollar: Time to See How the Outlook Stacks Up

Last week the focus of the currency market was on the US economy and interest rates. The Federal Reserve lowered the Fed funds rate by 50bp and two days later, the market learned that the US economy reported that 17k jobs were lost in the month of January, the first net job loss in 4 years. This week, the focus will shift away from the health of the US economy onto where US interest rates are headed compared to the rest of the world. Three central banks are meeting this week and three vastly different outcomes are expected. The Reserve Bank of Australia is forecasted to lift interest rates by 25bp to 7.00 percent and if they raise rates, they would be the last ones standing. When compared to the 125bp that the US Federal Reserve shaved off its own interest rate last month, it is clear why the US dollar has fallen to a 2.5 month low against the Australian dollar. A rate hike by the RBA would send the currency back towards its multi-decade high of 94 cents. The Bank of England on the other hand is expected to cut interest rates but if they fail to give the market what it wants, which is a quarter point interest rate hike expect a quick sell-off in the US dollar against the British pound. The European Central Bank on the other hand will be holding interest rates steady for the eighth consecutive month. As long as they retain the same degree of hawkishness, EURUSD losses should be limited. Factory orders were released this morning and even though they were slightly weaker than expected, the growth in orders was the strongest in 5 months. Service sector ISM will be out tomorrow. Like the manufacturing sector, growth in the service sector is expected to have slowed in the month of January. ISM should not be as market moving as it usually is because non-farm payrolls have already been released and the employment component of ISM is typically seen as a leading indicator for non-farm payrolls.

Could the Reserve Bank of Australia Really Raise Interest Rates?

The Reserve Bank of Australia will be announcing their monetary policy decision this evening and their announcement could set the tone for the entire market this week. If the RBA really raises interest rates not only will the Australian dollar rally, but we could see a nice run in carry trades as well. With everyone talking about global growth slowing, a rate hike from the RBA would mean that at least this central bank feels that their economy can handle tighter monetary policy. Based upon the 6 day rally in the Australian dollar, traders seem to agree. Of the 27 Economists surveyed by Bloomberg, every single one is calling for a quarter point rate hike. The sheer reality of 7 percent interest rates would send capital flooding into Australian dollars. Traders however need to be careful because everyone has jumped on the quarter point rate hike bandwagon, which means that if they do not raise interest rates, the currency will plunge quickly and sharply. Australian retail sales are expected to be released at the same time as the RBA rate decision, which means that it will be overshadowed by the monetary policy announcement. The December trade balance was released this morning and rising exports helped to narrow the deficit from 2.2B to 1.9B.