Why is the Australian Dollar strengthening as hot inflation fuels RBA rate hike bets?

Australia’s inflation overshoot put the RBA’s 2–3% target further out of reach as annual CPI climbed to a stronger-than-forecast 4.3% in September.
Following the upside inflation surprise, traders raised the probability of a November RBA rate increase to 78%.
While withholding firm guidance on policy action, RBA Governor Bullock cautioned that inflation was still far too high.

Gains in the Australian Dollar (AUD) following the domestic Consumer Price Index (CPI) release are supporting AUD/JPY, which is advancing for a fourth consecutive day. The cross is trading near 111.30 in Wednesday’s Asian session.

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

At 4.3% year-on-year in September, Australian CPI inflation exceeded the market estimate of 4.2% and August’s reading of 4.0%. The monthly increase also gathered pace, reaching 0.8% against the previous 0.4% rise and expectations of 0.7%. The Trimmed Mean CPI, an important gauge of underlying price pressures, recorded a 0.3% month-on-month increase and a 3.7% annual rise.

Expectations of a rate increase at the Reserve Bank of Australia’s (RBA) 3 November meeting strengthened considerably as the inflation surge took price growth further above its 2–3% target range. Traders assigned a 78% probability to a November hike after the release, compared with 70% beforehand. Although RBA Governor Bullock stressed that inflation remained far too high and aggregate demand was still exceeding supply, she gave no explicit signal on the board’s forthcoming decision.

Rising crude oil prices are weighing on the Japanese Yen (JPY) against its major counterparts by renewing cost pressures on large energy-importing economies. The increase in oil prices came as global financial markets followed election results emerging from Israel, with the potential to alter the course of the Middle East conflict.

With vote counting still under way, exit polls indicate a close contest between Prime Minister Benjamin Netanyahu and opposition leader Gadi Eisenkot, with neither bloc securing a clear majority. The initial results nevertheless suggest support for Netanyahu is waning despite the deadlock. A dominant figure in Israeli politics, he has led the country through nearly three years of conflict.

Central bank decisions due this week are now drawing close attention from market participants. Investors are assessing the prospect of policy changes in December, even as both the Federal Reserve and the Bank of Japan are widely expected to leave interest rates unchanged at this week’s meetings.

Australian Dollar: Key Questions Answered

Which factors matter most for the Australian Dollar?

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

Why do Reserve Bank of Australia decisions matter for the Australian Dollar?

By determining 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%, raising or lowering rates as needed. When RBA rates are relatively high compared with those of other major central banks, the AUD receives support; 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. If China’s growth falls short of expectations, the reverse applies. This relationship means that upside or downside surprises in Chinese growth figures often directly affect the Australian Dollar and its currency pairs.

Why do Iron Ore prices influence the Australian Dollar?

According to 2021 data, Iron Ore generates $118 billion in annual exports for Australia, making it the country’s largest export, with China the main destination. This makes its price an important potential driver of the Australian Dollar. Rising Iron Ore prices generally lift overall demand for the currency and strengthen the AUD; falling prices generally have the opposite effect. Higher prices also tend to increase the likelihood of Australia recording a positive Trade Balance, providing further support to the AUD.

Why does the Trade Balance matter for the Australian Dollar?

Another influence on the Australian Dollar is the Trade Balance: the difference between a country’s export earnings and its spending on imports. Strong overseas demand for Australian exports can lift the currency’s value when demand from foreign buyers exceeds Australia’s spending on imported goods. A positive net Trade Balance therefore supports the AUD, while a negative balance has the reverse effect.