stars align for the Australian dollar ahead of Reserve Bank meeting

The two-year return shed 11 basis points intraday before trimming losses to stand at 4.86 per cent on Monday. The 10-year rate hit an intraday low of 4.48 per cent on Friday to post the biggest weekly decline since July. It bounced to 4.59 per cent on Monday.

Meanwhile, the gap between US two-year to 10-year yields deepened to minus 29 basis points, from 18 basis points. An inversion – when short-term borrowing costs exceed those on the longer end – in that part of the curve indicates a looming recession.

Bond traders now imply just a 7 per cent chance of a US rate increase in December to the range of 5.5 per cent to 5.75 per cent, down from 20 per cent, while the probability of an increase in January is only 12 per cent from 28 per cent.

Traders less convinced

In Australia, RBA governor Michele Bullock is widely expected to lift rates with 33 of the 35 economists surveyed by The Australian Financial Review predicting the central bank will end its four-month rate pause on Tuesday and raise to 4.35 per cent. That’s after last week’s strong inflation and retail sales data.

Yet, money markets are less convinced, implying only a two-in-three chance of more tightening. Markets, however, are fully priced for a move by February and ascribe a strong chance of a follow-up increase to a peak of 4.6 per cent.

“The markets are giving them the green light and unless they want to wrong-foot the market as they’ve done many times, they should go tomorrow.” said Angus Coote, co-founder of Jamieson Coote Bonds. “If they don’t, the December meeting is live.”

Last month, the Ms Bullock said the RBA “will not hesitate” to lift interest rates if there was a material upgrade to its inflation outlook.

Should the central bank opt to keep rates on hold, the governor would need to explain “emphatically and explicitly” how the “inflation miss” was not “material”, said independent economist Saul Eslake, who expects a rate increase on Tuesday.

“If she doesn’t say it, and they don’t raise rates, there will be question marks in people’s minds about the Reserve Bank’s independence,” he added.

Economists expect the RBA policy statement to reiterate “that further tightening may be required to ensure that inflation returns to target in a reasonable timeframe” with some anticipating the central bank to harden its talk of higher rates.

“The longer they don’t act on that tightening bias, the weaker it becomes,” warned UBS strategist Giulia Specchia. According to UBS’ sentiment index, which tracks hawkish and dovish words in the RBA’s policy meeting minutes, the message has already weakened to “neutral” language.

Based on the underlying strength of the economy, the RBA should be more vocal about the risk of raising rates than it currently is, added Ms Specchia.

“So if they don’t go in November, then the market won’t believe they are committed to that tightening bias and will react accordingly with the next move more likely to be a cut and that will unwind the impact of any rate rises, ” she said. UBS also expects the central bank to lift rates.