A$ resumes downside after rates decision bounce; ISM data suggests inflation back on radar

Incoming economic data overnight continued to be evaluated in the context of how likely the Fed will come to the rescue and unleash QE3 at next week’s policy meeting. U.S equities initially reacted negatively to data showing sub-par manufacturing activity and a steep drop in contraction spending, nevertheless, bad news can also be good news should a less than inspiring data pulse strengthen the case for a third round of quantitative easing.

The release of ISM manufacturing index showed growth moderated further to 49.6 in August from a previous 49.8 – expectations were for a moderate rise to 50. A separate manufacturing PMI released by Markit edged up to 51.5 in August from 51.4 in July. An index level of 50 and above suggests manufacturing is expanding, below signals contraction. Construction spending in the region slumped 0.9 percent in July after a 0.4 percent rise in June. The price paid component of the ISM index rocketed to 54 from a previous 39.5 against predictions of a smaller rise to 46. Although the manufacturing component continued to point to sub-par growth, this is perhaps a telling sign inflationary pressures have once again infiltrated the broader economy, in light of the recent spike in energy and grain prices. Although in the past Fed Chairman Bernanke has describe such energy driven inflation as “transitory” it can also be seen as a stumbling block for the Federal Reserve to imminently embark on further easing initiatives.

After a solid post RBA policy meeting performance, the Aussie dollar resumed its slow grind lower against the greenback with price action forging fresh six-week lows to 102.14 US cents. The local unit initially firmed after the Reserve Bank left interest rates unchanged at 3.5 percent with the ensuing statement taking a tad more of a neutral tone than markets had priced in.  The statement acknowledged weakness from recent Chinese indicators, which is a delicate downgrade from the August statement which noted “China’s growth has moderated to a more sustainable pace, but does not appear to be slowing further.” The statement noted “growth in China remained reasonably robust in the first half of this year, albeit well below the exceptional pace seen in recent years. Some recent indicators have been weaker, which has added to uncertainty about near-term growth. Around Asia generally, growth is being dampened by the more moderate Chinese expansion and the weakness in Europe.” It also noted a firming of housing prices and business credit as a result of previous cash rate adjustments, of which have yet to fully infiltrate the broader economy. Little could be drawn from the brief mention of the recent fall in Australia’s key commodity exports, but continued to point out terms of trade have declined significantly “though they remain historically high”. Inflation is expected to be “consistent with the target over the next one to two years”. In essence, the statement justifies why interest rates are below their medium term averages, rather than building a case for additional cuts to the official cash rate.

The day ahead will see the local focus turn to the release of second-quarter GDP, which is expected to show quarterly growth of 0.8 percent down from 1.3 percent in the first quarter. In yearly terms, growth is expected to have fallen to 3.7 percent from 4.3 percent. At the time of writing the Aussie dollar is buying 102.2 US cents.

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