Australian Dollar holds firm despite weak Chinese data, fading RBA rate hike bets

• AUD/USD trades around 0.7030 on Friday, little changed on the day after reaching its highest level since mid-June.
• Weak official Chinese PMI data caps the Australian Dollar's upside, while the softer US Dollar limits downside pressure.
• Markets continue to price in Fed tightening, while expectations of another RBA rate hike have faded significantly.

AUD/USD trades around 0.7030 at the time of writing on Friday, little changed on the day after Thursday's strong rally. The Australian Dollar (AUD) continues to draw support from the persistent weakness in the US Dollar (USD), although the latest Chinese economic data is limiting the pair's upside potential.

Data released on Friday showed that China's manufacturing sector slipped back into contraction in July. The NBS Manufacturing Purchasing Managers Index (PMI) fell to 49.2 from 50.3 previously, missing market expectations of 50. Meanwhile, the Non-Manufacturing PMI declined to 49, also below forecasts. The figures highlight slowing activity in Australia's largest trading partner, a development that is generally negative for the Australian Dollar.

At the same time, the US Dollar remains under pressure after data released on Thursday showed that the United States (US) Gross Domestic Product (GDP) expanded by just 1.5% in the second quarter, down from 2.1% in the first quarter and below the market consensus of 2.1%. The weaker growth reading continues to weigh on the Greenback.

However, Australia's monetary policy outlook has shifted in recent days. While markets had previously expected another interest rate hike this year following hawkish comments from Reserve Bank of Australia (RBA) Governor Michele Bullock, the latest second-quarter inflation data has virtually ruled out a rate increase at the August 11 meeting. This reassessment of policy expectations is now limiting further gains in the Aussie despite the ongoing weakness in the Greenback.

Australia CPI eases RBA hike risks

Analysts at Deutsche Bank highlight that the latest Australia inflation print came in softer than expected, with “Australia’s consumer price index (CPI) rose +0.6% qoq in Q2 (vs. +0.7% expected and +1.4% in Q1), supported by easing fuel prices.” They note that headline price pressures continued to cool on an annual basis as “annual inflation moderated from +4.0% to +3.8% yoy.”

While underlying inflation showed a marginal uptick, Deutsche Bank stresses that “annual core inflation edged up from +3.5% to +3.6%, but remained below the consensus estimate of +3.7%, reducing the urgency for additional interest rate hikes after the RBA already raised rates three times this year.” In rates markets, they point out that “following the release, yields on 2yr Aussie government bonds are down -8.3bps to 4.49%, with markets paring back the chance of a rate hike next month to just 2%, from 18% previously.”