Why is the Australian Dollar falling despite RBA rate hike warnings?

Further interest rate increases may be needed to tackle persistent inflation, RBA Assistant Governor Sarah Hunter warned.
Markets assign a 90.6% probability to unchanged Fed rates in October, according to the CME FedWatch Tool.
Middle East risks remain on traders’ radar, with attention on US-Iran tensions and Houthi attacks in Saudi Arabia.

AUD/USD is under pressure near 0.7030 in Monday’s Asian session, reversing the modest advance recorded on the previous trading day. Losses could, however, be limited if the Australian Dollar (AUD) draws support from warnings issued by Reserve Bank of Australia (RBA) Assistant Governor Sarah Hunter.

TMGM Analysis: Financial Market News, Economic Calendar & Market Insights

Persistent inflation and the possibility that overseas price pressures could become embedded in the economy may require further interest rate increases, Hunter warned on Sunday. Following four rate hikes earlier this year, her comments strengthened expectations that monetary policy would remain restrictive.

September inflation figures, due later this week, are now in focus after August CPI stayed above the RBA’s 2% to 3% target range. Any fresh escalation in the US-Iran conflict that pushes crude oil prices higher would also intensify the RBA’s concerns about second-round inflation effects. That would raise the likelihood of additional policy tightening beyond November.

Can the RBA preserve credibility as inflation expectations move above target?

A troubling change in domestic inflation expectations is emerging, according to Commerzbank’s Norman Liebke. He points to survey findings showing “a growing share of businesses believe that inflation of 3-3.5% is ‘the new normal’.” Against the “long-term inflation target of 2-3%,” he sees this as a problem for the RBA’s inflation-targeting framework. Liebke stresses that the danger is more than theoretical: “trimmed-mean inflation most recently stood at 3.6%, further above the target range.” As markets increasingly factor in further RBA tightening, he believes elevated core inflation and shifting expectations together compound the challenge for policymakers.

The forthcoming Federal Reserve policy announcement is also drawing traders’ attention. Expectations broadly favour unchanged interest rates, with another increase potentially following in December. The CME FedWatch Tool indicates that markets assign a 90.6% probability to a pause at the October 27–28 policy meeting and a 79.7% probability to a December hike.

Geopolitical developments across the Middle East remain another focus for market participants. According to Al Jazeera, US President Donald Trump dismissed the prospect of immediate military action against Iran, saying, “there will not be a strike today,” after earlier suggesting that Washington might have to “finish the job” or potentially strike a deal with Tehran. Those earlier comments came amid mounting Iranian and Houthi threats to American interests in the region.

Regional tensions were further heightened on Sunday when Yemen’s Houthis said they would keep targeting Saudi Arabia’s King Khalid Airport in Riyadh, Reuters reported. Only hours earlier, Saudi officials had announced the resumption of flights at the airport despite repeated attacks by the group.

Australian Dollar: Common Questions

Which factors matter most for the Australian Dollar?

Interest rates set by the Reserve Bank of Australia (RBA) are among the strongest influences on the Australian Dollar (AUD). Australia’s abundant natural resources also make the price of Iron Ore, its largest export, a key driver. Other important influences include the performance of China, Australia’s biggest trading partner, alongside domestic inflation, economic growth and the Trade Balance. Investor appetite for risk matters too: demand for riskier assets, known as risk-on sentiment, supports the AUD, while a preference for safe havens reflects risk-off sentiment.

Why do Reserve Bank of Australia decisions affect the Australian Dollar?

By setting the interest rate at which Australian banks can lend to one another, the Reserve Bank of Australia (RBA) affects borrowing rates across the economy and, in turn, the Australian Dollar (AUD). Its primary objective is to keep inflation stable at 2-3%, using rate increases or reductions to achieve that goal. Rates that are relatively high compared with those of other major central banks support the AUD; relatively low rates have the reverse effect. Credit conditions can also be influenced through quantitative easing or tightening. Easing is negative for the AUD, whereas tightening is positive.

Why is China’s economic performance important for the Australian Dollar?

As Australia’s largest trading partner, China has a substantial influence on the Australian Dollar (AUD). A strong Chinese economy buys more Australian raw materials, goods and services, increasing demand for the AUD and lifting its value. When Chinese growth falls short of expectations, the reverse applies. This relationship means that both upside and downside surprises in China’s growth figures often directly affect the Australian Dollar and its currency pairs.

Why do Iron Ore prices influence the Australian Dollar?

With annual exports worth $118 billion according to 2021 data, Iron Ore is Australia’s biggest export, and China is its main destination. Its price can therefore influence the Australian Dollar. Rising Iron Ore prices generally lift the AUD by increasing overall demand for the currency, while falling prices have the opposite effect. Higher prices also tend to improve the prospect of a positive Australian Trade Balance, providing another source of support for the AUD.

Why does the Trade Balance matter for the Australian Dollar?

Another influence on the Australian Dollar is the Trade Balance, which measures export earnings against expenditure on imports. Strong overseas demand for Australian exports can lift the currency’s value because demand from foreign buyers exceeds the outflows needed to pay for imports. A positive net Trade Balance therefore supports the AUD, while a negative balance has the reverse effect.