The Reserve Bank of Australia is set to hike interest rates on Tuesday when it announces its decision at 04:30 GMT. But after surprising with a bigger-than-expected 25-basis-point increase at the last meeting, by what increment will policymakers raise rates this time? Recent data out of Australia has been mixed, but the long-awaited easing of virus curbs in China’s largest city – Shanghai – may have given the RBA the green light to be even bolder in June. The size of the rate hike, as well as any updated guidance on the projected rate path could determine whether or not the Australian dollar is able to stretch its recent rebound.

The economy is mostly strong

The Australian economy grew a solid 0.8% in the first three months of the year, beating estimates. Growth was surprisingly resilient despite a smaller current account surplus and a drop in business investment. However, the narrower trade surplus was down to exceptional demand for imports rather than a fall in exports as consumers splashed out. Hence, although some aspects of the recovery have been disappointing and there were the added challenges of Omicron and heavy flooding across parts of Australia to contend with in Q1, the economy is generally in good shape.

Just as relevant, if not more, is that virus restrictions in Shanghai are finally being relaxed and the recent easing of some curbs in other Chinese cities has already started to boost manufacturing activity. Moreover, the Chinese government just announced a comprehensive fiscal package to support regional economies and promote investment in infrastructure and tech industries. Whilst there’s a high risk that lockdowns could be re-imposed on the first sign of a fresh outbreak, the decline in infections for now does at least clear some of the fog in the growth outlook for China, which absorbs a large chunk of Australia’s exports.

A recipe for big rate hikes?

More to the point, however, for the RBA, the country’s consumer price index jumped to a 20-year high of 5.1% year-on-year in the first quarter, and the labour market remains tight. Wage growth has only picked up moderately, but it may only be a matter of time before it accelerates. Thus, given that it’s been rather late to the game, the RBA no longer has a strong case to go slow when it comes to tightening policy.

A 25-bps rate hike is fully priced in by the markets for June but there’s a substantial chance of an even bigger increase. Having taken the unusual step of lifting the cash rate from 0.1% to 0.35% at the last meeting, policymakers could decide to raise it by 40 bps to 0.75%.

Aussie rebound might stall without RBA boost

A 40-bps increase or more could add fresh steam to the aussie’s latest uptrend against the US dollar, which appears to be stalling near the 200-day moving average. The $0.7250 region also contains the 50% Fibonacci retracement of the April-May downtrend at $0.7244 so it might prove to be a tough resistance point. A hawkish tone would help overcome this hurdle, opening the way for the 61.8% Fibonacci of $0.7342, before aiming for the $0.7450 level.

However, if the RBA raises rates by only 25 bps and does not signal its willingness to get more aggressive in the upcoming meetings, the aussie could come under selling pressure. The 38.2% Fibonacci of $0.7146 is the key support to the downside. If breached, the 23.6% Fibonacci of $0.7024 could next be targeted before the losses reach the 23-month low of $0.6827 set in mid-May.

Beyond the June meeting, investors are heavily betting that the cash rate will rise by at least a further eight times (of 25-bps increments) by year-end. Now that the tightening cycle is getting well and truly underway, there is a risk that the RBA’s hawkish rhetoric will not match the aggressive pricing by investors – something that could thwart the aussie’s comeback bid.