Australian Dollar weakens against Japanese Yen as chances of RBA rate hikes fall
- AUD/JPY posts modest losses near 113.65 in Thursday’s early European session.
- Softer Australian CPI inflation weakens the case for an RBA rate hike.
- BoJ is widely expected to hold the interest rate steady at its July policy meeting on Friday.
The AUD/JPY cross declines to around 113.65 during the early European session on Thursday. The pair currently trades 0.65% lower on the week as the likelihood of the Reserve Bank of Australia (RBA) raising interest rates has fallen. Traders await Japan’s Tokyo Consumer Price Index (CPI) inflation report and the Bank of Japan (BoJ) interest rate decision later on Friday.
Australia’s headline CPI inflation eased to 3.8% YoY in June from 4.0% in May, the Australian Bureau of Statistics showed on Wednesday. This figure came in softer than the market expectations of 4.0%.
This report has reduced market bets on an immediate interest rate hike by the Reserve Bank of Australia (RBA), weighing on the Aussie. Market pricing for an August rate hike fell from nearly 21% down to about 3% to 4% following the Australian inflation report, according to Reuters.
The Bank of Japan (BoJ) is widely expected to keep its interest rate steady at 1.0% at its July policy meeting on Friday, following June's hike to a 31-year high. However, policymakers are signaling a hawkish outlook driven by a weak Japanese Yen and rising import costs.
Traders will closely monitor the BoJ's quarterly outlook report and Governor Kazuo Ueda's press conference for clues on how soon it could raise still-low borrowing costs. Analysts polled by Reuters expect the Japanese central bank to raise rates to 1.25% by end-December and possibly as early as October.
RBA comforted as Australia inflation undershoots core forecast
According to TD Securities, the softer-than-expected inflation print in Australia should ease immediate policy concerns at the RBA. The bank notes that "Australia Q2/June CPI was lower than expected, which should reassure RBA officials that inflation pressures are kept in check." Strategists highlight that the core gauge closely watched by policymakers also surprised on the downside, with the "Q2 trimmed mean measure (i.e., core), which the RBA focuses on, [having] printed at 3.6% y/y and lower than the RBA's May Statement of Monetary Policy forecast at 3.8% y/y." This combination of headline and core readings reinforces the view that underlying price pressures are moderating relative to the RBA’s earlier projections.
Inflation FAQs
Inflation measures the rise in the price of a representative basket of goods and services. Headline inflation is usually expressed as a percentage change on a month-on-month (MoM) and year-on-year (YoY) basis. Core inflation excludes more volatile elements such as food and fuel which can fluctuate because of geopolitical and seasonal factors. Core inflation is the figure economists focus on and is the level targeted by central banks, which are mandated to keep inflation at a manageable level, usually around 2%.
The Consumer Price Index (CPI) measures the change in prices of a basket of goods and services over a period of time. It is usually expressed as a percentage change on a month-on-month (MoM) and year-on-year (YoY) basis. Core CPI is the figure targeted by central banks as it excludes volatile food and fuel inputs. When Core CPI rises above 2% it usually results in higher interest rates and vice versa when it falls below 2%. Since higher interest rates are positive for a currency, higher inflation usually results in a stronger currency. The opposite is true when inflation falls.
Although it may seem counter-intuitive, high inflation in a country pushes up the value of its currency and vice versa for lower inflation. This is because the central bank will normally raise interest rates to combat the higher inflation, which attract more global capital inflows from investors looking for a lucrative place to park their money.
Formerly, Gold was the asset investors turned to in times of high inflation because it preserved its value, and whilst investors will often still buy Gold for its safe-haven properties in times of extreme market turmoil, this is not the case most of the time. This is because when inflation is high, central banks will put up interest rates to combat it. Higher interest rates are negative for Gold because they increase the opportunity-cost of holding Gold vis-a-vis an interest-bearing asset or placing the money in a cash deposit account. On the flipside, lower inflation tends to be positive for Gold as it brings interest rates down, making the bright metal a more viable investment alternative.
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