On July 31st, traders will need to prepare for the release of Australia's second quarter CPI data. This is an obvious event risk as the inflation data results may significantly impact the policy expectations of the August 6th Reserve Bank of Australia meeting. Furthermore, the CPI data may trigger an unconscious reaction in interest rate-sensitive stocks such as consumer stocks, banks, and real estate investment trusts that are denominated in the Australian dollar foreign exchange currency pair, AUS200, and ASX200. Product structure, 10-30 billion yuan products operating income of 401/1288/60 million yuan respectively.
The Reserve Bank of Australia recently stated that the bank still remains cautious of upward inflation risks and stated that "the current uncertainty means it is difficult to determine the likelihood of cash rate changes in the future."
Although the Australian economy is not all rosy, the service industry inflation is still well above the level that the central bank hopes for, making it a key reason for the central bank to consider raising interest rates by 25 basis points besides inflation hovering around the central bank's target.
It's worth noting that June's employment report recorded a net gain of 0.05 million jobs, May's retail sales increased by 0.6%, household spending increased by 4.3%, and national house prices rose for 16 consecutive months. Therefore, some people may think that the Australian economy can easily absorb a 1.92% real cash rate, the highest level since 2011.
Therefore, if we see an increase in CPI data for the second quarter, this could upset the balance and force the Reserve Bank of Australia to take action.
Chart: Current Australian trimmed mean CPI inflation is up 4% year-on-year
Australian CPI script:
The core CPI that excludes the highest and lowest price changes in CPI calculation is called the trimmed mean CPI, which is an important indicator that the Reserve Bank of Australia pays closer attention to than the overall CPI.
1. If Australia's second-quarter CPI is up more than 4% year-on-year, the implied probability of a 25 basis point hike in interest swap increases from 30% to 50-60% (Australian dollar rises, ASX200 falls) for interest-sensitive stocks, such as consumer stocks, bank stocks, and real estate investment trusts.
2. If Australia's second-quarter CPI is less than 3.8% year-on-year, the implied probability of a 25 basis point hike in interest swap drops from 30% to 15-20% (Australian dollar drops, ASX200 rises)
3. If Australia's second-quarter CPI is between 3.8% and 3.9% year-on-year, the implied probability of a rate hike remains at about 25-30% (Australian dollar slightly drops, ASX200 rises)
Recent high-frequency data indicates that the second-quarter CPI growth rate may rise by 1% QoQ, slightly higher than the central bank's own forecast for 3.8% year-on-year (both the overall and trimmed mean indicators). With the likelihood of a 25 basis point interest rate hike in August at 30% in the futures market, if the second-quarter trimmed mean CPI is over 4%, the implied probability will rise to 50-60%. This means that the Reserve Bank of Australia meeting comes with subtle expectations.
Chart: Economic forecasting by RBA
Conversely, if we see the trimmed mean CPI for the second quarter fall below 3.8%, not only will it be slower than the growth rate in the previous quarter, but it will also be lower than the central bank's own forecast (as outlined in their May monetary policy statement). If we see this number equal to or below 3.7%, we may see the implied probability of an interest rate hike drop to 15-20%.
Another factor is that if the CPI data warms up moderately, then whether adding 25 basis points to the discount rate will have any impact on total demand, consumption patterns, and ultimate inflation. Most importantly, we should consider that there is a significant difference between a symbolic 25 basis point interest-rate hike and the start of a new cycle of such hikes.
Some people believe that although a one-time interest rate increase of 25 basis points may harm families that are already in a difficult situation, most Australian families and consumers will quickly adapt to life under a 4.60% cash rate.
Of course, if average families think there will be more rate hikes to come, consumption may be hit hard, and many will talk up the word "recession" more casually.
We can see that the swap/interest rate traders believe that interest rates should start falling from April 2025. Therefore, the strong market view is that if a rate hike does happen, it will be the most difficult rate hike in history, and there may be a reversal in the second quarter of 2025.
Given this, if the central bank ultimately increases interest rates by 25 basis points in August, what is more important for the Australian market is the central bank's choice of words and whether they open the door for further interest rate increases in the future. The so-called "hawkish interest rate hike", that is, the central bank's interest rate hike and the possibility of further interest rate hikes, may really exacerbate market volatility. This seems like an unlikely outcome, but if this is the path taken by the central bank, it may lead to a massive sell-off of ASX200, and traders believe that the central bank's "least regret path" will end in significant regret.
The Reserve Bank of Australia will indeed consider the developments overseas, but with most G10 and emerging market central banks either cutting interest rates or about to, an interest rate hike by the Reserve Bank of Australia will make them a huge exception.