RBA rate hike bets rise as hot inflation lifts Australian Dollar

4.3% was Australia’s annual CPI inflation rate in September. The jump beat forecasts and put inflation above the RBA’s 2–3% target.
78% was the probability traders assigned to a November RBA rate increase after inflation exceeded expectations.
While warning that inflation was still far too high, RBA Governor Bullock stopped short of providing firm policy guidance.

111.30 is the approximate level for AUD/JPY in Wednesday’s Asian session. The cross is advancing for a fourth consecutive day, supported by Australian Dollar (AUD) strength following the domestic Consumer Price Index (CPI) release.

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At 4.3% year-on-year in September, Australian CPI inflation exceeded both August’s 4.0% and the market’s 4.2% forecast. Monthly price growth accelerated to 0.8% from 0.4%, also beating the expected 0.7%. The Trimmed Mean CPI, a key gauge of underlying inflation, recorded a 0.3% monthly increase and a 3.7% annual rise.

With inflation moving further above the Reserve Bank of Australia’s (RBA) 2–3% target range, expectations of a rate increase at its 3 November meeting strengthened significantly. Traders raised the probability of a November hike from 70% before the release to 78% afterwards. RBA Governor Bullock stressed that aggregate demand still exceeds supply and described inflation as far too high. She did not, however, give explicit guidance on the board’s forthcoming decision.

Higher crude oil prices are weighing on the Japanese Yen (JPY) against major currencies by renewing cost pressures on economies heavily reliant on energy imports. Oil advanced as global financial markets followed unfolding election results in Israel, which could alter the direction of the Middle East conflict.

With vote counting still under way, exit polls indicate a close race between Prime Minister Benjamin Netanyahu and opposition leader Gadi Eisenkot. The two are tied, with neither bloc holding a clear majority. Despite the stalemate, early results suggest support is weakening for Netanyahu, a dominant figure in Israeli politics who has led the country through nearly three years of conflict.

This week’s key central bank meetings are the next focus for market participants. Interest rates are widely expected to remain unchanged at both the Federal Reserve and the Bank of Japan. Investors are also assessing the prospects for possible policy changes in December.

Australian Dollar: Key Questions Answered

The Main Drivers of 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 resource wealth also makes the price of iron ore, its largest export, a key driver. Other influences include the economic health 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 AUD, while a preference for safe havens reflects risk-off conditions.

RBA Policy and Its Effect on the Australian Dollar

By setting the interest rate at which Australian banks can lend to one another, the Reserve Bank of Australia (RBA) influences borrowing costs across the economy and, in turn, the Australian Dollar (AUD). Its primary objective is stable inflation of 2-3%, pursued through increases or reductions in interest rates. Rates that are relatively high compared with those of other major central banks support AUD; relatively low rates have the reverse effect. Quantitative easing and tightening provide additional ways for the RBA to influence credit conditions. Easing is negative for AUD, whereas tightening is positive.

China’s Economic Health and 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 AUD and lifting its value. When Chinese growth falls short of expectations, the reverse applies. Chinese growth figures that surprise on either the upside or downside can therefore directly affect the Australian Dollar and its currency pairs.

Iron Ore Prices as a Driver of the Australian Dollar

According to 2021 data, iron ore is Australia’s biggest export, worth $118 billion annually, with China its main destination. Changes in its price can therefore influence the Australian Dollar. Rising iron ore prices generally lift aggregate demand for AUD and strengthen the currency; falling prices tend to have the reverse effect. More expensive iron ore also increases the likelihood of an Australian trade surplus, which provides further support for AUD.

The Trade Balance and the Australian Dollar

Another influence on the Australian Dollar is the trade balance: export earnings minus import expenditure. Strong overseas demand for Australian exports can lift the currency because foreign buyers generate more demand for AUD than Australia spends on imports. A positive net trade balance therefore strengthens AUD, while a negative balance has the reverse effect.