AUD/USD retreats as soft Australian Inflation supports stable RBA policy, Fed policy eyed

• AUD/USD has fallen back as soft Australian inflation grabs the spotlight.
• The USD Index remains under pressure as investors have digested expected hawkish Fed policy.
• Australian inflation has softened despite the tight labor market, which has compressed fears of recession.

The AUD/USD pair has sensed selling pressure after a fragile recovery of around 0.6780 in the European session. The Aussie asset is expected to remain under pressure as Australian inflation softened in June and has offered some relief to Reserve Bank of Australia (RBA) policymakers to maintain interest rates steady consecutively in August.

S&P500 futures have posted nominal losses in London, portraying caution among market participants ahead of the interest rate decision by the Federal Reserve (Fed). The US Dollar Index (DXY) dropped sharply to near 101.15 but has attempted a recovery move as investors seem uncertain about guidance to be delivered by Fed Chair Jerome Powell.

As per the CME FedWatch tool, almost all bets are in favor of a 25 basis point (bp) interest rate hike, which will push interest rates to 5.25-5.50%. The context that is making investors anxious is the guidance from the Fed about September’s monetary policy.

Inflation in the United States economy is consistently declining despite tight labor market conditions and a rise in consumer spending but is still far from the desired rate of 2% due to rising cost of prices. Also, consumer inflation expectations could rebound as global oil prices have recovered this month. Therefore, Jerome Powell could reiterate the need of one more interest rate by the year-end.

On the Australian Dollar front, inflation in the second quarter grew at a pace of 0.8% vs. expectations of 1.0% and the prior quarter’s reading of 1.4%. Annualized Consumer Price Index (CPI) softened to 6.0% against the consensus of 6.2% and the prior figure of 7.0%. Meanwhile, monthly CPI matched the consensus of 5.4%.

Australian inflation has softened despite the tight labor market, which has compressed fears of recession. A decline in inflationary pressures would allow the Reserve Bank of Australia (RBA) to skip the policy-tightening spell straight for the second time.