Australian Dollar Falls Back As A Weak PPI Foreshadows Same The For CPI

CPI (YoY) (1Q) (01:30 GMT)
CPI Market Prices (YoY) (1Q) (01:30 GMT)
Expected: 3.0%
Expected: 2.6%
Previous: 3.3%
Previous: 2.3%


How Will The Markets React?

Support for a Reserve Bank of Australia rate hike next week has quickly diminished. What was once a strong case for another 25 basis point boost in the overnight cash rate to 6.50 percent is now a consensus for a pass. The turning point for policy watchers and traders was the producer price index for the first quarter. Heading into the release, the market sought a 0.6 percent pick up in factory-level prices for the three months while the annual figure sat ominously sans consensus. Officially, the PPI hit the wires with no change for the quarter which marks the second time in three and a half years that the indicator failed to report positive growth. At the same time, the annual gauge decelerated from 3.5 percent to 2.8 percent for the slowest pace of growth since the second quarter of 2004. While the producer price gauge has unsettled hawkish rate projections, the Australian dollar, bonds and equities have all refrained from making their respective breakout moves. Though the factory-level indicator has handicapped a shift, the deciding factor for speculation lies with the forthcoming Australian consumer price index. Despite the PPI’s shortfall, the official consensus for the CPI is still relatively elevated. For the quarter, inflation is expected to have rebounded 0.6 percent from a 0.1 percent contraction in final months of 2006. Perhaps the annual indicator is more in line with the recently released data as economists foresee a deceleration from a 3.3 percent rate to 3.0 percent. On the other hand, if the year-over-year pace comes in line with expectations; it could very well keep a RBA hike on track. The central bank is charged with keeping inflation between a 2 to 3 percent band, and a 3.0 percent print would mark the fifth consecutive quarter that prices have held at or above the top of the band. Regardless of the outcome for inflation, all of the Australian markets are set to move.
Bonds -10- Year Australian Government Bonds
After a disappointing showing from the producer price index, yields on Australia’s benchmark 10-year government bond dropped 5 basis points to 5.933. Despite the move, price action for the contract has yet to upset the delicate technical setup. The pull back brought yields in line with a rising trend channel that has been in play since the beginning of March. At the same time, topside price action is controlled by a 6.0 percent ceiling. While most traders were aware that a big surprise in today’s PPI could move the market, they also knew that the true move would not come until after the consumer price index was disseminated. The consumer-level inflation gauge is the more important number for policy makers, and it will be the deciding factor for speculation and an eventual breakout for bonds.

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FX - AUD/USD[/B]
The Australian dollar continues to threaten 16.5 year highs just above .8400 as traders consider the possibility that the Reserve Bank of Australia will raise rates to 6.50 percent at their next monetary policy meeting. However, the softer-than-expected release of the Producer Price Index quelled some concerns that price pressures were rapidly mounting. Nevertheless, AUDUSD holds above support near .8300 ahead of first quarter consumer prices. The CPI figure could finally push the Australian dollar to break out of its tight range above resistance at .8390, as a strong release may easily bring the central bank to hike their benchmark. On the other hand, the cooler producer price figure signals that consumer price growth was indeed tepid in the first quarter readings, which would subsequently raise expectations that the RBA will leave rates at 6.25 percent. As a result, AUDUSD could break down below a steep supporting trendline towards .8200.

Equities - ASX 200 Index
A weaker-than-expected reading of the producer price index for the first quarter left Australian equities relatively flat ahead of the release of the consumer price index for the same period. The close of the Sydney session found the S&P/ASX200 index up a mild 1.7 points at 6209.2, as improvements in mining shares were offset by losses in the financial sector. A rise in metals prices led BHP Billiton up 15 cents to AU$30.00 and Rio Tinto 54 cents stronger at AU$83.96. However, major banks like Westpac fell 20 cents to AU$27.15 while ANZ sagged 13 cents to AU$31.08.
The actual consumer price index release could make or break price action for the S&P/ASX 200, as the figure is anticipated to fall back to an annualized 3.0 percent from 3.3 percent. Such a decline would take the edge off of rate hike expectations for the Reserve Bank of Australia - which already maintains a lofty benchmark of 6.25 percent - leaving Australian equities free to work higher towards the intraday high of 6,252.30. On the other hand, a hotter-than-expected inflation reading could force the RBA to consider raising rates, thus the prospects of increased borrowing costs could send the S&P/ASX 200 plummeting towards 6,000.