Interest rate stability sparks Aussie volatility

The Australian dollar was the big winner out of this afternoon’s statement by the central bank, as the Reserve Bank gave up its easing bias.

The RBA set currency markets abuzz this afternoon following its first meeting for 2014. In what was a keenly anticipated media statement the central bank departed from previous statements, sending the Aussie dollar higher.

Since the last statement on December 3, the RBA has removed reference to an “uncomfortably high” Aussie dollar. The other big change comes at the conclusion of the statement with the board taking the view that “the most prudent course is likely to be a period of stability in interest rates”. A clear signal that they do not expect to have to adjust the cash rate for a while.

This is a policy shift from an easing bias to a neutral stance and suggests there is a chance we have seen the low in interest rates for this cycle. It doesn’t necessarily remove the possibility of another reduction in the cash rate altogether, though it does push the possibility out till May or June at the earliest -- depending on data.

The RBA doesn’t appear to be too concerned about inflation. Despite the fact that fourth quarter CPI was higher than expected they assume some “moderation” over time as labour costs continue to slow with unemployment likely to continue higher. So labour force data holds the key to policy in 2014.

Aussie soars ahead of more key Australian data this week

The statement was enough for markets to begin the process of covering short AUD positions in the Aussie dollar. Within minutes of the decision the local unit had taken out overnight highs, trading back above 0.8830 against the greenback. Offshore markets are likely to continue the trend this evening with a move beyond 89 cents appearing imminent.

Graph for Interest rate stability sparks Aussie volatility

The currency volatility is also set to be influenced by Thursday’s Australian Retail Sales and Trade Balance, however the market may be looking a little further ahead to Friday’s Monetary Policy report for more detail from the RBA.

From a technical perspective the next major resistance level (above 89 cents) is the January 13 high of 0.9085 but I suspect any move to 90 cents may be short lived. There are still some major concerns surrounding equity markets, emerging markets and of course Friday’s U.S employment report which could reverse any strength between now and then.

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