Australian dollar rallies as inflation shock rings rate alarm

SYDNEY: The Australian dollar popped higher on Wednesday after data showed inflation accelerated by much more than expected in May, slamming bonds as investors priced in a greater risk of another increase in interest rates.

The monthly consumer price (CPI) report showed annual inflation rose to 4.0% in May, from 3.6% in April and well above forecasts of 3.8%.

A key core measure also picked up to 4.4%, the highest reading in six months and a major surprise.

The Reserve Bank of Australia (RBA) had already warned it was alert to upside risks to inflation, meaning another hike in rates could not be ruled out.

“This will give room to the RBA to continue beating the rate hike drum for now and will also support the AUD, particularly on the crosses against currencies of central banks that remain dovish,” said Charu Chanana, head of FX strategy at Saxo.

Markets quickly lifted the probability of a rate hike to 39%, from 12% before the data, with a move likely in August following the release of the full second-quarter CPI report.

Futures also priced out any chance of a cut in the 4.35% cash rate this year, and had only 20 basis points of easing implied by the end of 2025 compared to 44 basis points early in the day.

The Aussie firmed 0.4% to $0.6675, and looked set to test resistance around $0.6679. The New Zealand dollar lagged at $0.6117, having spent the past few days stuck in a tight $0.6105/6140 range.

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Three-year Australian bond futures slid 14 basis points to 95.970, the sharpest daily drop in two months.

Yields on 10-year bonds climbed 11 basis points to 4.315%.

The CPI report for the June quarter is due on July 31, just days before the RBA’s policy meeting on Aug. 7.

The central bank had expected core trimmed mean measure of inflation to slow to 3.8% in the quarter.

“The monthly data suggest that annual trimmed mean inflation may have remained around 4.0% in Q2,” said Marcel Thieliant, head of Asia-Pacific economics at Capital Economics.

“However, with the economy doing worse than it has been anticipating, we think the RBA will take the upside surprise in its stride,” he added, and still looks for the next move to be a cut early next year.