Australian Dollar Awaits RBA Rate Decision Amidst US Tariff Uncertainty

AUD

The broad tariff relief rally lifted the Australian dollar to its highest level on the greenback since mid-December last week, with the AUD/USD pair ending the London session on Friday above the 0.63 threshold. The Aussie currency somewhat lagged behind most other major currencies, however, particularly the European ones, as investors brace for the possibility that the Reserve Bank of Australia will use this week’s policy meeting to kick off its easing cycle. Swap markets see around an 85% chance of a cut on Tuesday. While we agree that a cut is not a done deal, we still have a 25bp rate reduction as our base case scenario.

On the one hand, policymakers will be encouraged by the recent strength of the labour market. Yet, we think that we’ve seen enough evidence of an easing in both wages and inflation for the doves on the committee to get their way. Aside from the rate decision itself, we will be paying very close attention to the bank’s remarks on the possible impact of US tariffs on the policy path. Markets are pricing in around 75bps of cuts through year-end, and we suspect that the RBA will keep its options open to at least match these expectations, particularly given the uncertainty surrounding Trump’s trade restrictions.

NZD

The Reserve Bank of New Zealand is practically certain to lower interest rates again at its meeting on Wednesday. The real debate surrounds the size of the move lower in rates, with markets torn between a 25bp and 50bp move (43bps priced in by swaps). With inflation now seemingly back under control, economic activity decidedly weak and the labour market showing signs of deterioration, we see the latter as far more likely than the former.

With another bumper rate move not fully priced into the value of the kiwi, there appears to be clear room for downside in the event of a 50bp cut. Of course, this will also be dependent on the tone of the bank’s communications. Recent data gives us little reason to believe that the remarks won’t be on the dovish side. We suspect that the bank will flag heightened concerns over the growth outlook, particularly in light of the tariff risk, while voicing greater confidence on inflation. Any indication that rates could fall to 3% (or lower) this year would be particularly bearish for NZD, which we continue to believe remains set to underperform its Aussie counterpart over our forecast horizon.

USD

Trying to predict the next tariff news to hit the newswires is a bit of a fool’s errand, so it is perhaps more productive to focus more on the macroeconomic backdrop. Last week’s nonfarm payrolls report was, once again, consistent with a US labour market that remains strong. Companies continue to create jobs at a healthy clip, the unemployment rate is hovering around levels consistent with full employment, and the report showed a surprise uptick in wages in January – monthly earnings rose at their fastest pace since mid-2023.

All of this positive economic news, plus the looming threat of price hikes from Trump’s tariffs, makes it increasingly difficult to justify any further interest rate cuts at all from the Fed in 2025. With rates in the US remaining almost the highest in the G10, we think that it will be difficult for the dollar to sell-off in spite of its admittedly very expensive levels.

CNY

The yuan managed to recover some of its earlier losses last week. Risk sentiment has turned more favourable and a 7% uptick in Hong Kong’s main index, Hang Seng, was particularly impressive, with hopes of China-led AI technology further boosting sentiment. Recent remarks from PBOC’s Governor Pan Gongshen reiterated the increasing authorities’ focus on consumption. He also praised yuan’s stability and his tone on the exchange rate reinforces our belief that the bank will not allow the currency to drop too much too fast.

US headlines, particularly the ones relating to tariffs, should remain key for the yuan for now. The domestic economic calendar is fairly empty aside from LPR setting on Thursday, with no change expected to either 1- or 5-year rate. PBOC’s 1-year MLF rate is also expected to remain stable with authorities likely to wait for a bit more clarity on tariffs before they engage in more significant policy adjustments.

JPY

The yen has been the best performer in the G10 so far in 2025, as markets brace for another interest rate hike from the Bank of Japan at its January meeting later in the week. Recent economic news and communications from BoJ officials, particularly governor Ueda, suggest that another rate increase at Friday’s policy meeting is far more likely than not. Swaps currently see a little more than an 80% chance of a 25 basis point hike, so another month of inaction would be a major disappointment for investors and would almost certainly trigger a sharp move lower in the yen across the board.

We do not think that policymakers will want to disappoint investors again, particularly given their wariness over the impact of a weaker currency on inflation. We instead expect the BoJ to follow through with a hike, while delivering a non-committal set of accompanying communications that fails to provide any guarantees on the timing of any subsequent policy adjustments. This would likely still be enough to buoy the yen, which remains one of our favoured G10 currencies in 2025.