GBP/AUD recovery stalled following RBA’s lift-off GBP/AUD risking probe below 1.75 in short-termIf Fed aids AUD/USD & BoE burdens GBP/USD

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The Pound to Australian Dollar exchange rate entered the holiday-shortened week close to its April highs but would risk slipping back beneath the 1.75 handle in the days ahead if the Federal Reserve (Fed) reinforces a nascent upturn in AUD/USD or if the Bank of England (BoE) weighs on Sterling.

Sterling had rallied sharply against the Australian Dollar ahead of the holiday weekend but stalled just above the 1.78 handle early in the new week and could be at risk of handing back more of last Friday’s gains over the coming days.

GBP/AUD already fell briefly back toward the 1.75 handle during Tuesday’s European session after the Reserve Bank of Australia (RBA) surprised the markets with a larger-than-expected initial increase in its benchmark cash rate.

Tuesday’s 0.25% increase took the benchmark up to 0.35% and represents a departure from RBA guidance that had suggested in February it could be months, if not more than year, before borrowing costs need to rise from their crisis-induced record lows.

“The evidence that we have received since then on inflation is clear. It was high. And higher than expected,” Governor Philip Lowe said on Tuesday.

Above: GBP/AUD shown at daily intervals with Fibonacci retracements of January decline and selected moving-averages indicating possible areas of short-term technical resistance for Sterling and support for the Aussie. Click image for closer inspection.

“Given this evidence on inflation and wages and the very low level of interest rates, the Board decided that now was the right time to start the process of normalising interest rates,” Governor Lowe also said in a speech explaining the RBA’s decision on Tuesday.

The RBA also announced an immediate halt to reinvestments of the monies it receives from the Australian government each time a bond held on its balance sheet reaches its maturity date as part of its expanding effort to withdraw inflationary pandemic-related monetary support from the economy.

All of this is after Australian inflation rose by 2.1% in the first quarter alone, surprising the RBA and all major private sector forecasters while also lifting the annual rate of inflation to 5.1%, which is more than twice the 2.5% midpoint of the RBA’s two-to-three percent target range.

"Australian interest rate futures already imply a cash rate of 2.75% by year‑end. By comparison, the RBA’s new macroeconomic forecasts (released on Thursday) assume a cash rate at 1.50‑1.75% by year‑end," says Elias Haddad, a senior currency strategist at Commonwealth Bank of Australia.

“CBA’s new base case is a cash rate of 1.35% by year‑end (25bps hikes in June, July, August and November 2022) and 1.60% by February 2023. Our more dovish RBA policy‑path view remains a major drag for AUD,” Haddad and colleagues also said on Tuesday.

Above: AUD/USD at daily intervals with fibonacci retracements of April’s two respective legs lower indicating possible areas of short-term technical resistance to an Aussie Dollar rebound and support for the U.S. Dollar. Click image for closer inspection.

Gains for AUD/USD and losses for GBP/AUD were quick to fade on Tuesday but could be reignited later in the week if the Federal Reserve defers an anticipated announcement about quantitative tightening (QT) in the U.S. on Wednesday and if the BoE dampens appetite for Sterling on Thursday.

“As has been well-advertised and equally well-anticipated by markets, Wednesday’s FOMC will deliver a 50bp hike in Fed funds target rate, as well as the announcement of quantitative tightening (QT), another step in the Fed’s front-loaded tightening” says John Velis, an FX strategist at BNY Mellon.

“We expect to hear additional details of the QT program, the outlook for rates policy into the summer, and some clarity on how much of a concern inflation is for the Fed,” Velis and colleagues said on Tuesday.

There is a risk of a decision to defer the resort to quantitative tightening, which would potentially tamp down U.S. government bond yields and stall a recently strengthening rally in the U.S. Dollar with likely favourable implications for currencies like the Australian Dollar.

This would be just ahead of Thursday’s BoE decision, which would likely need to include a significant ‘hawkish’ surprise in order to rejuvenate market appetite for Sterling and avert any fresh or further declines in GBP/AUD.

Above: AUD/USD shown at weekly intervals with fibonacci retracements of 2020 rally indicating possible areas of medium-term technical support for the Australian Dollar and resistance for the U.S. Dollar. Click image for closer inspection.