- RBA sits on hands again as yield-support for AUD continues to fade.

- RBA sees risks to households and inflation only a "little above 2%".

- AUD/USD on defensive but solid support eyed at 0.75, GBP/AUD falls.

© Goroden Kkoff, Adobe Stock

The Australian Dollar slipped during the morning session in London Tuesday as traders shunned the currency in light of declining yield-support and after the Reserve Bank of Australia left markets guessing on the question of when an Aussie interest rate rise will eventually come.

Policymakers held the RBA cash rate at a record low of 1.5% for May and, although Governor Philip Lowe struck an upbeat tone on the domestic and international economic outlook, the Bank provided little by way of assurance on whether interest rates will return to normal levels any time soon.

The decision comes at a crucial time for global foreign currency markets with an apparent regime shift underway in which interest rates and bond yields appear to be exerting a growing influence. And unfortunately for the Aussie Dollar, with the RBA unlikely to boost Australian interest rates and yields anytime soon, support is in short supply.

"The Bank's central forecast for the Australian economy remains for growth to pick up, to average a bit above 3 per cent in 2018 and 2019. This should see some reduction in spare capacity in the economy," says Governor Lowe, in a statement Tuesday. "One continuing source of uncertainty is the outlook for household consumption, although consumption growth picked up in late 2017. Household income has been growing slowly and debt levels are high."

Lowe also flagged that inflation remains low and is likely to remain so for some time to come, given weak wage growth in recent years and strong competition in the retail sector. The RBA forecast is for consumer prices to be "a bit above 2%" in 2018, suggesting the Bank expects inflation to remain at the lower end of the 2% to 3% target range.

If these inflation forecasts are proven correct they will leave arguments in favour of an interest rate rise this year looking even weaker because it is changes in inflation that dictate whether and when rates change. If inflation threatens the upper bound of its target range rates might go up and vice versa.

"Nothing in today’s Statement alters our long held view that the RBA will remain very tardy in lifting rates for the first time this cycle. We still see the RBA’s first move not coming until November 2018, at the earliest," says John Peters, an economist with Commonwealth Bank Australia.

CBA do warn of a "clear risk to our view" in the shape of the RBA deciding to wait a bit longer (i.e. the first half of 2019) "before moving to hike rates if there is a lack of any hard evidence of intensifying wage or price pressures and given widespread evidence of moderating national house price."

Pricing in interest rate derivatives markets implies a May 19, 2019 cash rate of just 1.7%, which suggests traders do not currently expect an interest rate rise from the Reserve Bank until well into the 2019 year.

Above: AUD/USD rate shown at hourly intervals.

The AUD/USD rate was quoted 0.29% lower at 0.7510 during the morning session Tuesday although the Pound-to-Australian-Dollar rate was down 0.33% at 1.8222 due to a weak Sterling.

Above: Pound-to-Australian-Dollar rate shown at hourly intervals.

"The AUD has proved vulnerable to the rise in short term US rates – which the RBA acknowledge have risen for reasons other than a rise in Fed Funds. We acknowledge that AUD will face a tough week from upside risks to US rates, but the local AUD story doesn’t look that bleak. 0.7500 remains key AUD/$ support," says Chris Turner, global head of FX strategy at ING Group.

Current interest rate expectations are a problem for the Aussie in today's market because rising rates elsewhere, particularly in the US, are undermining support for the Antipodean currency. US 10 year Treasury yields remain close to the key 3% threshold and offer better returns to international investors than those of their Australian counterparts.

Above: US 10 Year Government Bond Yield.

The Aussie 10 year yield was just 2.76% Tuesday and will struggle to rise for the length of time the RBA sits on its hands.This means investors might be more inclined to sell Aussie Dollars to buy US Dollars and bonds during the weeks ahead.

Above: Australian 10 Year Government Bond Yield.

What's more, the direction of travel for Aussie yields relative to those of other developed world currencies is also unfavourable for the Australian Dollar given the Bank of Canada and Bank of England are both expected to raise rates again later this year while the European Central Bank is also expected to take steps to "normalise" its monetary policy.

"We are negative on the Aussie, but strong mining stocks are not making an easy case at the moment – watching the AUDUSD area at 0.7500 and whether this holds for now," says John Hardy, chief FX strategist at Saxo Bank.

The next crunch point for the Aussie will come in the middle of May when first-quarter wage growth numbers are released. Wage growth can have a significant influence over demand in an economy and so it is also important for inflation expectations.

A strong wages number this month could encourage markets to consider whether they are being too pessimistic in their expetations for interest rates, which would have positive implications for the Aussie Dollar. The last set of figures were a disappointment as they showed pay growth driven entirely by one-off changes in public sector pay and the minimum wage.

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