Following Surprise RBA Interest Rate Hike
By Sumit Roy,02 November 2010 06:51 GMT 
The Australian Dollar has spiked higher following a surprise interest rate hike by the Reserve Bank of Australia. In particular, AUD/USD is approaching parity, a significant level which has acted as resistance for the pair since mid-October.
The RBA has raised rates to 4.75 percent from 4.50 percent, where rates previously stood for six months. Markets were not expecting an interest rate hike at this meeting; overnight index swaps were implying only 28% chance of a hike, or equivalently, a 72% chance that rates would be held steady. Ironically, the situation was reversed at the prior meeting in October. At the time, markets were implying a 74% chance of a hike, but the RBA surprised with no hike.
Taking a look at the accompanying statement, the RBA noted that “the turmoil in financial markets earlier in the year has abated, though sentiment remains fragile.” The central bank was especially upbeat on the Australian economy, expecting “stronger private spending over the next couple of years, especially business investment.” But what really seemed to tip the scale in favor of a rate hike was the RBA’s belief that “inflation is likely to rise over the next few years.” All things considered, the bank felt that “early, modest tightening of monetary policy was prudent.”
Unsurprisingly, future interest rate hike expectations have risen substantially following the latest policy decision. Markets are now expecting 61 basis points of rate hikes over the next twelve months, which is on top of the 25 basis points we got today. Prior to the decision, only 44bp were expected, but that was excluding today’s 25bp.
Looking forward, it will be difficult to arrest the Australian Dollar’s advance as economic growth and interest rate differentials remain extremely supportive of the currency. The next big event risk is the highly-anticipated Federal Reserve policy decision. The risk to the Aussie is if the Fed comes out with a smaller-than-expected quantitative easing program. While it is difficult to gauge market expectations in this situation, market commentators have been bandying about a $500 billion figure. If the actual figure is substantially smaller than that, we may see a broad rally in the U.S. Dollar, which would have an adverse impact on AUD/USD. Otherwise, an outcome that is close to expectations will merely reinforce the extremely strong uptrend in the Australian Dollar.
