ING cuts AUD/USD year-end target to 0.72, sees RBA hike as barrier to June lows

Since most of the rate increase is already reflected in prices, the Australian dollar's reaction will hinge on the RBA's statement and Governor Bullock's press conference, particularly regarding whether November remains an option. Oil prices are the key variable because fuel cost pass-through is a central inflation worry for the RBA, making headlines about Iran diplomacy directly influence rate expectations. A diplomatic deal that pushes crude lower could reduce that concern, while renewed escalation would reinforce it. The global bond sell-off and US Treasury yields above 5.2% continue to weigh on AUD/USD, regardless of the RBA's decision.

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Earlier reports:

• Near-term support for the AUD from an RBA hike is seen by NAB, but medium-term risks are seen in the opposite direction.
• RBA preview: A 25bp rate rise to 4.60% is broadly anticipated as inflation remains persistent.
• Persistent core inflation is driving the RBA toward its highest cash rate since 2011.
• RBA preview: A 25 bps rate increase is already priced in, but the focus is on what follows.
• All four major Australian banks currently expect the RBA to raise rates to 4.60% on September 29.
• RBA Governor Bullock highlights inflation risks as higher neutral rate estimates gain attention.
• RBA's Bullock states supply shocks are difficult for policy to handle, and flags second-round risk.
• RBA's Hunter indicates rates might need to increase again as inflation risks remain skewed to the upside.

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ING expects the RBA to implement a hawkish rate increase today, citing persistent inflation and a strong labor market, which will provide some support to the battered Australian dollar but not a clear recovery.

Here is a summary of ING's views:

• ING predicts the RBA will raise the cash rate by 25bp to 4.6% today, stating the economy remains overheated, with a tight labor market, an upside GDP surprise in Q2, and firmer inflation data, even as housing shows some cooling.
• Inflation dangers are seen as skewed upward following the US-Iran conflict, as Australia depends on imported diesel, petrol, and jet fuel; ING references RBA calculations that a 10% fuel price increase could boost headline inflation by more than 0.3 percentage point.
• ING anticipates that trimmed mean inflation remained at 3.6% in August for the third month in a row, contradicting the RBA's projection of 3.3% by year-end.
• Labor demand stays robust, with unemployment at 4.6%, average monthly job creation over three months of roughly 34,000, and a record participation rate of approximately 67%.
• ING considers AUD/USD undervalued following a tough week and lowered its year-end forecast to 0.72 from 0.73; a dip below 0.70 is possible in the near term, but a rate hike should prevent a revisit of the June lows around 0.69.
• ING projects one rate increase from both the RBA and the Fed, with the Fed's move expected in December; an October Fed hike would maintain demand for the US dollar.

ING forecasts a 25 basis point rate increase to 4.6% from the Reserve Bank of Australia today, contending that the economy remains heated on multiple fronts. In a September 25 preview, the bank noted a tight labor market, an upside surprise in Q2 GDP, and stronger-than-expected recent inflation data. Although housing has shown some cooling, ING expects the RBA to emphasize that inflation risks are still skewed upward and that continued vigilance is required to bring price pressures back to target sustainably.

ING outlines three factors behind its hawkish stance. Firstly, the US-Iran escalation has increased inflation risks. Despite being a major LNG and thermal coal exporter, Australia heavily depends on imported oil products like diesel, petrol, and jet fuel; higher global oil prices have already increased domestic fuel costs, raising input costs in transport, mining, and agriculture. ING cited RBA estimates that a 10% fuel price rise could add over 0.3 percentage point to headline inflation over one to two quarters, with indirect effects adding another 0.2 to 0.25 percentage point. ING expects crude oil prices to ease but anticipates domestic fuel prices will remain sticky.

Secondly, ING noted that trimmed mean inflation likely stayed at 3.6% year-on-year in August for a third consecutive month, indicating that core inflation accelerated in Q3 rather than slowing, which challenges the RBA's forecast of 3.3% by year-end. Thirdly, labor demand remains strong even as unemployment rose to 4.6%. Full-time employment growth picked up in July and August, the three-month average job creation increased to around 34,000—the fastest since the conflict began in February—and participation hit a record of about 67%. ING said this raises the risk that wage and underlying inflation pressures remain persistent.

Regarding the currency, ING stated that the Australian dollar had a difficult week due to weak risk appetite and a global bond sell-off; its short-term fair value model indicates AUD/USD is undervalued by more than 1.5 standard deviations. ING identified the US dollar leg as the key uncertainty: an October Fed hike could keep the greenback in demand and postpone a recovery, but if the next Fed hike occurs only in December as ING expects, the AUD could lead G10 currencies during a US dollar correction. ING noted that markets price in about 22bp for the RBA this week and roughly another 40bp over the next nine months, compared with about 90bp for the Fed by July 2027, leaving less scope for a dovish repricing in Australia.

ING projects one rate increase from both the RBA and the Fed, and stated that the rate differential should become more favorable for AUD/USD. It lowered its year-end AUD/USD forecast to 0.72 from 0.73. In the immediate term, a dip below 0.70 is a risk, ING said, but a rate hike from the RBA should avert a repeat of the June lows around 0.69.

Focus now shifts to the RBA's statement and Governor Bullock's press conference for clues about the policy path following today's decision.