What’s Next for the Aussie?

In their latest policy decision, Glenn Stevens and his buddies at the Reserve Bank of Australia (RBA) decided to give the markets a nice Halloween surprise by hiking rates by another 0.25%. According to the minutes of their meeting, RBA policymakers based their decision to increase interest rates on the expected acceleration of inflation.

In fact, RBA officials noted that annual inflation surged beyond their 2-3% target in October. They estimate that the rise in consumer prices will moderate in the near term, but could still exceed their target by mid-2011. The RBA’s hawkish tone was also supported by forecasts that project that the Australian economy will expand by 3.75% by the end of 2011.

Do these optimistic estimates hint at another rate hike?

Well, market junkies aren’t exactly keeping their fingers crossed. My forex minions told me that bets for another rate hike only range from 15% to 25%. This is probably because the RBA already considered the medium-term risks and benefits of raising its interest rates.

Also, recent economic events are favoring a pause in hiking rates. For one, the unemployment rate rose from 5.1% to 5.4% in October. And then there are the consumers who are feeling the weight of high interest rates. The Westpac Consumer Confidence report released earlier this month dropped by 5.3% mainly because more consumers are getting jumpy on higher mortgage payments that come with high interest rates.

Last but not the least, global economic risks have come back to haunt the markets like the ghost in Paranormal Activity haunts Katie Featherston’s family. You see, one of the factors in the RBA’s interest hike was presumably the lessening of risks to global economic recovery.

But now that talks of Ireland’s possible bailout, doubts on the Fed’s QE, and even the possibility of China raising interest rates have popped up in markets, the RBA now has more reasons to keep its borrowing costs steady.

Even though the Aussie is unlikely to enjoy an RBA rate hike for Christmas this year, it could still end the year on a high note. For one thing, the Fed’s decision to pump even more money in the U.S. economy could provide a boost for the Aussie. Recall that the dollar has been on a major slide the past couple of months as investors have shied away and instead have been moving their funds towards the Australian dollar. Why? Duh, high(er) interest rates!

And let’s not forget the impact of gold. Gold has become increasingly attractive lately, as it serves not only as an alternative investment, but as a hedge as well. With all the confusion in the markets, gold has remained strong over the past year, benefiting from both risk aversion and risk appetite. This in turn, has also benefitted the Aussie, as it has a strong correlation with gold. With the bullish run showing no signs of slowing down, we could see both gold and the Aussie climb up the charts.

There are however, some concerns about the effects of a rising Aussie on the economy. If the Australian dollar continues to rise, it could present problems down the line for Australian exports. Remember, a strong currency can reduce demand for a country’s exports, as its good become more expensive relative to that of its competitors. If AUD/USD bursts through parity once again and post new highs, it will be interesting to see what effect this could have on the Australian economy.