Australia: Headline inflation back in the band, AUD remains capped - Westpac

The research team at Westpac suggests that despite the fact that Australia’s headline inflation has crept into the bottom end of the RBA band for the first time since Q3 2014, the core trimmed mean outcome of 0.48%qq/1.9%yy suggests discounting remains a factor depressing price pressures.

Key Quotes

“The modestly weaker than expected Australian CPI outcome has added yet another factor capping the A$ today: softer commodity prices; a more protectionist stance from US President Trump on Canadian lumber imports and higher US yields leave the A$ with strong resistance towards 0.7580/90. We remain a seller of strength up into the 0.7600/50 region if seen and expect to see the A$ heading towards 0.74 by year end.”

“For bonds:

• Ahead of the release our expectation was that the risk reward was skewed toward more bearish outcomes. That is, given the heaviness of USTs in recent sessions as the “risk on” thematic has dominated, we expected a stronger data outcome to see bond futures sell-off more than a below consensus number sparking a major rally. As it turned out, there was a small pop higher in 3yr & 10yr bond futures prices on the announcement, but they were quickly given back. That suggests that 3yr bond futures will need to trade toward the 98.05-08 level before we seeing buying on the dip.
• More medium term, this will have little influence on those who maintain that, while the likelihood of a near term RBA rate cut remains low, it is a more likely scenario than an RBA hike. Indeed, with a core inflation profile still below 2%, there is very little risk of that scenario being priced-out of market valuations for now.
• In addition, there is little reason for the curve to steepen to cater for a higher inflation outlook. So we continue to expect the curve to remain broadly within a 70-80bp range, with our preference still leading toward entering flatteners on moves to 80bp or so. It will also cap any domestic-led widening in the AU-US 10yr bond spread, which we think is capped between 35-40bp.”