Another ugly inflation surprise ignites risk of August RBA hike

Australian inflation overshot expectation by some distance in May
We have seen three consecutive upside surprises from Australia’s inflation indicator
Earlier this month, the RBA said it will do what is necessary to bring inflation back to target
With inflation moving further away from its mandate, an August hike is deemed a line-ball call
AUD/USD, Australian bond yields surge, ASX 200 tanks

RBA August meeting live for a hike

There is now little doubt underlying inflationary pressures in Australia are accelerating again, increasing the risk the Reserve Bank of Australia (RBA) will be forced to hike interest rates for the first time since November.

Three-peat of inflation overshoots

Australia’s May inflation report was uncomfortably hot, continuing the pattern seen in recent months. Headline inflation accelerated to 4.1% in the year to May, up from 3.8% in April and three tenths higher than expected.

The news on underlying inflation was even worse with the key trimmed mean measure lifting 4.4% over the year. Not only was that nearly two full percentage points above the midpoint of the RBA’s 2-3% inflation target band but a significant acceleration on the 4.1% pace seen in April. That's important as this is the RBA's preferred inflation gauge.

As shown in the chart below, there are now serious doubts about inflation not only returning to the RBA’s target band with a clear acceleration seen in both headline and underlying measures.

Source: ABS

RBA wriggle room is shrinking fast

For the RBA, the update has seen the upside inflation risks it flagged at its June monetary policy materialise, even before income tax cuts and a variety of energy and transportation subsidies hit the pockets of Australian households next week.

“The path of interest rates that will best ensure that inflation returns to target in a reasonable timeframe remains uncertain and the Board is not ruling anything in or out,” it wrote two weeks ago. “The Board remains resolute in its determination to return inflation to target and will do what is necessary to achieve that outcome.”

Right now, markets believe the RBA may need to resume its tightening cycle to achieve its goal, deeming an increase in the cash rate to 4.6% on August 6 as a coin toss. Prior to the inflation report, the probability of such an outcome was priced around 10%.

Three-year Australian yields surge

Australian three-year government bond yields – which are sensitive to changes in the interest rate outlook – surged around 14 basis points following the report, putting it on track for the largest increase since April.

AUD/USD breaks pennant resistance

That contributed to AUD/USD lifting as much as 0.5%, seeing it break through the top of the bull pennant formation it had been sitting in since the middle of May. Should the breakout stick, it points to a possibility of AUD/USD testing the top of its range highs above .6700.

ASX 200 SPI futures reverse hard

With the risk of higher rates threatening to slow economic activity and reduce the yield appeal of equities over safer asset classes, Australian ASX 200 SPI futures were hammered, losing more than 1%, reversing the gains achieved on Tuesday.

For now, it remains comfortably within the bull pennant it’s been in over the past seven weeks May. Should we see a downside break, futures were well bid from 7685 earlier in June.

-- Written by David Scutt

Follow David on Twitter @scutty

How to trade with City Index

You can trade with City Index by following these four easy steps:

Open an account, or log in if you’re already a customer

• Open an account in the UK
• Open an account in Australia
• Open an account in Singapore
Search for the market you want to trade in our award-winning platform
Choose your position and size, and your stop and limit levels
Place the trade

This report is intended for general circulation only. It should not be construed as a recommendation, or an offer (or solicitation of an offer) to buy or sell any financial products. The information provided does not take into account your specific investment objectives, financial situation or particular needs. Before you act on any recommendation that may be contained in this report, independent advice ought to be sought from a financial adviser regarding the suitability of the investment product, taking into account your specific investment objectives, financial situation or particular needs.

StoneX Financial Pte. Ltd., may distribute reports produced by its respective foreign entities or affiliates within the StoneX group of companies or third parties pursuant to an arrangement under Regulation 32C of the Financial Advisers Regulations. Where the report is distributed to a person in Singapore who is not an accredited investor, expert investor or an institutional investor (as defined in the Securities Futures Act), StoneX Financial Pte. Ltd. accepts legal responsibility to such persons for the contents of the report only to the extent required by law. Singapore recipients should contact StoneX Financial Pte. Ltd. at 6826 9988 for matters arising from, or in connection with the report.

In the case of all other recipients of this report, to the extent permitted by applicable laws and regulations neither StoneX Financial Pte. Ltd. nor its associated companies will be responsible or liable for any loss or damage incurred arising out of, or in connection with, any use of the information contained in this report and all such liability is hereby expressly disclaimed. No representation or warranty is made, express or implied, that the content of this report is complete or accurate.

StoneX Financial Pte. Ltd. is not under any obligation to update this report.

Trading CFDs and FX on margin carries a high level of risk that may not be suitable for some investors. Consider your investment objectives, level of experience, financial resources, risk appetite and other relevant circumstances carefully. The possibility exists that you could lose some or all of your investments, including your initial deposits. If in doubt, please seek independent expert advice. Visit www.cityindex.com/en-sg/terms-and-policies for the complete Risk Disclosure Statement.

ALL TRADING INVOLVES RISKS. LOSSES CAN EXCEED DEPOSITS.

City Index is a trading name of StoneX Financial Pte. Ltd. (“SFP”) for the offering of dealing services in Contracts for Differences (“CFD”). SFP holds a Capital Markets Services Licence issued by the Monetary Authority of Singapore for Dealing in Exchange-Traded Derivatives Contracts, Over-the-Counter Derivatives Contracts, and Spot Foreign Exchange Contracts for the Purposes of Leveraged Foreign Exchange Trading. SFP is also both Derivatives Trading and Clearing member of the Singapore Exchange (“SGX”). SFP is a wholly-owned subsidiary of StoneX Group Inc.

The information provided herein is intended for general circulation. It does not take into account the specific investment objectives, financial situation or particular needs of any particular person. You should take into account your specific investment objectives, financial situation or particular needs before making a commitment to invest, including seeking advice from an independent financial adviser regarding the suitability of the investment, under a separate engagement, as you deem fit. No representation or warranty is given as to the accuracy or completeness of this information. Consequently, any person acting on it does so entirely at their own risk.

The information does not represent an offer of, or solicitation for, a transaction in any investment product. Any views and opinions expressed may be changed without an update. To understand the risks and costs involved, please visit the section captioned “Important Information” and the “Risk Disclosure Statement”.

The information herein is not directed to, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in any locality, state, country or other jurisdiction where such distribution, publication, availability or use would be contrary to law or regulation.

StoneX Financial Pte. Ltd. 1 Raffles Place, #18-61, One Raffles Place Tower 2, Singapore 048616. Tel: 6309 1000. Co. Reg. No.: 201130598R.

This advertisement has not been reviewed by the Monetary Authority of Singapore.