RBA policy decision (Tue) likely to be a close call

Markets will be closely watching the Reserve Bank of Australia (Tue), with some expecting a possible rate cut on the back of weak inflation data. A strong business sector and solid employment outcomes on the other hand suggest that demand is heading in the right direction. But last week’s very low inflation number have raised the odds of a rate cut tomorrow sharply. 

Data released on Monday showed that Australia's Business conditions eased in April to +9.2 from a reading of +11.8 in the previous month. Similarly, business confidence came in at +5.1, slightly lower compared to +6.2 in March. Despite retreating from last month’s peaks, Australia's business conditions and confidence remain around elevated levels and continue to suggest that the business environment is positive at present.

That said, last week’s dismal 1Q CPI print has fuelled RBA easing expectations. Latest round of inflation data released by the Australian Bureau of Statistics last week showed consumer prices unexpectedly fell 0.2 percent in the first quarter compared with the December 2015 quarter. Annual inflation also slowed, rising 1.3 percent in the 12 months to March 2016, compared with a 1.7 percent annual increase in the 12 months through December 2015. 

"Inflation was not just mildly below expectations, it was dramatically below even the lowest of expectations. The RBA has long placed its central focus on inflation targeting, with a watchful eye to ensuring financial stability. There is now little question that inflation is sufficiently low to justify an easing." said Goldman Sachs in a report.

The trade-weighted AUD has rallied by more than 6% since late Jan. Markets are pricing in a strong chance of a cut this week (circa 60% probability). Either way, a sharp response from the AUD is assured. The dramatic weakness in Q1 inflation has greatly changed the calculus for the outlook on Australian interest rates. The Aussie dollar is increasingly reflecting this changing perception towards the RBA’s policy settings, having lost 2.8% over the past eleven sessions. AUD/USD upside gathers pace ahead of RBA. The pair was trading at 0.7636 at 1100 GMT.

"Overall, the positive business environment exacerbates the dilemma for the RBA at tomorrow’s meeting. On balance, we expect the RBA to keep the cash rate on hold but acknowledge that this is a line-ball call." said ANZ in a report.