Forex trading: The Australian dollar is in focus as we head into another monetary policy decision from the Reserve Bank of Australia (RBA).

Coming into the meeting, the Australian dollar suffered a big drop at the end of April as inflation data disappointed. But AUDUSD is still trading close to its best level in nearly a year as a softer greenback helps support the Aussie.

With weak inflation, markets are positioning for some dovish signals from the RBA this time – but what should we expect?

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What Happened Last Time

 

At its April meeting, the RBA once again left rates on hold at 2%, with the bank noting risks to emerging markets but some improvement in commodity prices.

“Sentiment in financial markets has improved recently after a period of heightened volatility. However, uncertainty about the global economic outlook and policy settings among the major jurisdictions continues,” commented governor Glenn Stevens.

The RBA also indicated that it’s worried about a strengthening Aussie dollar and is prepared to act if the outlook worsens.

“Continued low inflation would provide scope for easier policy, should that be appropriate to lend support to demand,” added Mr Stevens.

What to Look For

 

Barring an outright cut to the cash rate, markets will be watching how the RBA views the recent slump in inflation and its impact on future policy decisions.

Prices fell by 0.2% in the first quarter from the previous three-month period – the first deflationary signal since 2008.

This was a sharp reversal from the 0.4% gain in the final three months of 2015 and dragged the annual rate down to 1.3%.

Reacting to the figures, the Aussie cratered as investors saw the data as supportive of more accommodation from the central bank.

But does the new inflation data really change things? Last time, the RBA noted that “inflation is quite low” and that it “is likely to remain low over the next year or two”.

Commodity Prices

 

The inflation report ended a rally for the Aussie that had lifted it to its strongest level since June. Recovering commodity prices, not least a 25% rise in iron ore in the first quarter, has helped the currency.

Better data from China has also helped but the inflation figures highlight that improvements are hard-won and commodity markets remain fragile.

“Expectations of more policy stimulus in China in the near term appeared to have contributed to increases in iron ore and steel prices, both of which have risen substantially from their lows around the turn of the year,” the RBA said in minutes from its last meeting.

“Members noted that this would imply a modest near-term rise in Australia's terms of trade, should current levels of commodity prices be sustained. However, at the same time, Chinese steel production had declined further and the global supply of iron ore was expected to increase as new mines ramped up production during 2016.”

The last time the RBA eased was a year ago, at its May 2015 meeting, when commodity prices were tanking and all the talk was of the Fed raising rates.

This time, commodity prices are firmer and the expectations of US rates rising are diminishing.