Rising pressure on a reluctant RBA to ease further

The market has increased pricing of the risk of further easing due to the transmission of weaker regional growth. The AUD may need further depreciation on a TWI basis considering the current pressure on the terms of trade. Inflation break evens are falling with the 3y breakeven around 1.70% currently, well below the base of the RBA target zone at 2.0%.

This may be distorted by supply of inflation-linked bonds, but even so it should be a reminder of policy risks. Wages growth remains weak so there does not appear to be a risk to inflation should the Bank decide to support growth via easier policy, especially a recent hikes in borrowing rates for investors in housing has tightened policy at the margin and means the transmission mechanism for easier policy is more muted. 

The China devaluation has reinforced the seasonal bias for bond yields to fall. With month-end approaching, equity stresses moving to extreme levels and further policy responses expected, this seasonal bias is expected to fade. 

"We note signs of weaker underlying demand at tenders, increasing pressure on fiscal balances as a result of slower growth and commodity price weakness and risk of some adjustments by reserve managers in EM Asia response to regional currency pressures", says BofA Merrill Lynch.