FX - AUD/USD: Trading the Australia Consumer Price Report

Trading the News: Australia Consumer Prices

Why Is This Event Important:

Price growth in Australia is expected to expand at a faster pace in the fourth-quarter, and the rebound in inflation could spark a sharp rally in the exchange rate as investors speculate the Reserve Bank of Australia to tighten monetary policy further this year. According to Credit Suisse overnight index swaps, market participants are pricing at least one more 25bp rate for the next 12 months, and the inflation report could spur a rise in interest rate as the rebound in economic activity gathers pace.

What’s Expected:

Time of release:01/25/2011 0:30 GMT, 19:30 EST

Primary Pair Impact :AUDUSD

Expected: 3.0%

Previous: 2.8%

Will This Be Market Moving (Scenarios):

Consumer prices are forecasted to grow at an annualized rate of 3.0% in the fourth quarter, while the core rate of inflation is projected to increase 2.6% following the 2.5% expansion during the three-months through September. As price pressures intensify, the RBA may adopt a hawkish tone for future policy, but we expect the central bank to retain its wait-and-see approach throughout the first-half of the year as Governor Glenn Stevens sees inflation expectations “consistent” with its medium-term target for price growth.

The Upside

As consumer inflation expectations widen to the highest level since August 2008, with businesses facing rising commodity prices, firms are likely to pass on higher costs onto consumers as the rise in economic activity gathers pace. A marked rebound in price growth could lead the AUD/USD to retrace the decline from earlier this month, and the exchange rate may work its way back above parity as investors expect the RBA to tighten monetary policy further this year.

The Downside

However, as the expansion in global trade cools, businesses may show an increased willingness to absorb higher costs as households cope with rising borrowing costs paired a slowdown in job growth. Accordingly, a slower pace of price growth could instill a bearish outlook for the Australian dollar, and the exchange rate may extend the decline from earlier this month as interest rate expectations falter.

How To Trade This Event Risk

Expectations for higher inflation certainly encourages a bullish outlook for the Australian dollar, and price action following the release could set the stage for a long aussie trade as investors speculate the RBA to tighten monetary policy further this year. Therefore, if the CPI advances to 3.0% of higher in the fourth-quarter, we will need a green, five-minute candle following the report to establish a buy entry on two-lots of AUD/USD. Once these conditions are met, we will set the initial stop at the nearby swing low or a reasonable distance from the entry, and this risk will generate our first objective. The second target will be based on discretion, and we will move the stop on the second lot to breakeven once the first trade reaches its target in order to lock-in our profits.

In contrast, businesses may keep a lid on consumer prices as the rise in borrowing costs drags on private sector activity, and a smaller-than-expected expansion in price growth would allow the RBA to maintain a neutral policy stance as it aims to balance the risks for the region. As a result, if the headline reading for inflation misses expectations for holds flat from the third-quarter, we will take the same approach for a short aussie-dollar trade as the long position mentioned above, just in reverse.

Potential Price Targets For The Event

Impact the change in Australia employment has had over the AUD during the last month

3Q 2010 Australia Consumer Prices

Consumer prices in Australia grew at an annual pace of 2.8% in the third quarter after expanding 3.1% during the three-months through June, while the core rate of inflation increased 2.5% amid forecasts for a 2.6% rise. A deeper look at the report showed prices for clothing and footwear increased 1.4% after holding flat in the second-quarter, with the cost of housing advancing 2.3%, while food prices slipped another 0.5% after contracting 0.3% during the previous period. Indeed, the Australian dollar tumbled lower following the weaker-than-expected inflation report, with the exchange rate slipping to a daily low of 0.9651, and easing price pressures could lead the Reserve Bank of Australia to maintain a wait-and-see approach in 2011 as it aims to balance the risk for the region.

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To discuss this report contact David Song, Currency Analyst: dsong@fxcm.com