AUD Faces Crucial Week as RBA Meets to Decide Interest Rates

The Australian dollar is expected to face a significant test this week as the Reserve Bank of Australia (RBA) meets to decide on interest rates. The market has assigned around a 95% probability to a 25bp hike, taking the cash rate from 4.35% to 4.60%. However, the decision's impact on AUD will depend not just on the rate hike but also on whether Governor Michele Bullock signals that further tightening is necessary.

The RBA has been concerned about inflation, which remains above the 2-3% target range. Core inflation is at 3.6%, while unemployment at 4.5% has not weakened enough to alleviate inflation concerns. A hawkish message from the RBA on Tuesday would be followed by Australia's August CPI release on Wednesday, which could reinforce or challenge the central bank's stance.

AUD/USD is currently testing an important technical support cluster around 0.7000-0.7025. The currency has pulled back sharply from its September high of around 0.7240 and needs a stronger signal than just a rate hike to recover further. AUD/NZD, on the other hand, may offer a cleaner expression of the RBA's divergence with the Reserve Bank of New Zealand (RBNZ).

The trader takeaway is that the market should not assume a RBA hike automatically means a higher AUD. The currency needs a stronger signal than just a rate hike, and traders should listen for language suggesting another hike may be necessary.