AUD: Hot inflation reaffirms rate cuts remain some way off

Key points:

• Australia’s April inflation came in hot.
• The RBA is likely to delay rate cuts and maintain a tightening bias.
• However, rate hikes are unlikely to be back on the table.
• Quarterly inflation print due on July 31 is more important.
• AUD likely to be supported by higher commodity prices and property sector measures from China.

Australia’s inflation came in higher-than-expected for April.

• Headline: 3.6% YoY (vs. 3.5% prior and 3.4% expected)
• Core: 4.1% YoY (unchanged)
• Trimmed mean: 4.1% YoY (vs. 4.0% prior)

This has once again raised concerns about the final stretch of inflation moving back to target—something we have often heard for many major economies, including the US. Meanwhile, fiscal spending, supply chain rejigging, green transformation, and trade re-mapping continue to suggest higher structural inflation.

With inflation showing upside pressures and moving away from the RBA’s target band of 2-3%, this further affirms that the RBA will have to delay rate cuts. However, the April inflation print is unlikely to bring rate hikes back to the table because:

• The monthly CPI in Australia is not the official measure tracked by the RBA. The central bank, instead, focuses on the quarterly inflation measure, which is only due on July 31.

• Australia’s labor market is softening, with the April unemployment rate rising to 4.1% as migration normalizes, dampening growth in labor supply. However, this is not fast enough to keep pace with the slowing labor demand.
• Australian consumers are struggling due to high interest rates and inflation. Retail sales in April came in below expectations, and the annual pace of 4.3% growth was significantly below the 4-5% growth seen in 2023.

Still, the RBA is likely to maintain a tightening bias given the Fed’s posturing and still-high inflation. As we have argued before, the RBA may well be one of the last G10 central banks to cut rates. This can continue to support the AUD, and the focus may shift away from yield differentials to:

• Higher commodity prices, which have enabled a considerable rebound in Australia’s terms of trade. Australia is one of the largest exporters of copper, which is seeing increased demand due to green transformation and AI development.
• China ramping up stimulus measures and taking steps to address the headwinds in the property sector. Recent measures included easing property sector rules in Shanghai, which can continue to support demand for industrial metals from Australia. More measures from China can be expected ahead of the Third Plenum to be held in July.

There are, however, a few risks to consider:

• Increasing trade tensions between the US and China can adversely affect the AUD.
• A faster-than-expected slowdown in the Australian economy.
• Any sharp devaluation of the Chinese yuan, as China aims to support its export engine, could filter down to the AUD.