Currencies wait for Reserve Bank of Australia to kick off big central bank week

The dollar hovered below recent highs on Tuesday as traders waited for the Reserve Bank of Australia to lead a handful of central bank meetings set to define the rates outlook this week. 

The RBA, Federal Reserve and Bank of England all meet with surging inflation looming over financial markets. 

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Australia issues its policy decision at 0330 GMT and some sort of guidance change is expected after the bank failed to defend its yield target as bonds sold off over recent sessions. 

The Fed also begins a two-day meeting later on Tuesday, where it is expected to announce tapering of its asset purchases, and the BOE meets on Thursday with markets all but pricing in a small rate hike. 

Moves were slight in morning trade, with the yen a fraction weaker at 114.11 per dollar and the greenback nursing a small overnight loss on the euro, following softer-than-expected U.S. manufacturing data. 

The euro last bought $1.1599. The Aussie, which had been steady through a week or so of wild selling in the domestic bond market, held at $0.7521, though volatility gauges point to a bumpy week. 

"The RBA meeting is widely considered `live` after the RBA failed to defend its 0.1% April 24 bond yield target in the wake of stronger than expected inflation data last week," said Commonwealth Bank of Australia analyst Kim Mundy.  

"We expect the RBA will abandon the 0.1% target while also changing its forward guidance on the timing of the first hike in the cash rate from 2024," she said. "In our view, AUD can fall if the RBA is not as hawkish as market pricing, but may find support around the technical level of $0.7379." 

Analysts said the kiwi could track moves in its Australian counterpart, while the broader market may also be sensitive to the bank`s tone in addressing inflation as its U.S. and UK peers face similar dilemmas. 

The kiwi was marginally softer at $0.7177 in morning trade. Sterling was also on the back foot at $1.3656, but moves were small ahead of the Fed and the BOE. 

"The elephant in the room is headline and underlying inflation, which are higher than the (Fed) was anticipating," said Standard Chartered`s head of G10 FX, Steve Englander. 

"We expect the (Federal Open Market Committee) to state that the Fed is ready to act decisively if inflation is not moving towards target levels when tapering ends, but it still expects inflation to fall as supply constraints ease. We think investors will see this as advancing the likely timing of Fed rate hikes," he said. 

"We expect FX markets to react to the implied Fed threat of rates moving off zero but discount inflation optimism. This adds up to a dollar-positive combination of higher real rates and increased risk-off positions." 

Trader positioning also points to bets on higher rates, with speculators crowding in to short the yen. 

"That`s a bet that interest rate trends will continue to move against the yen as they rise elsewhere, particularly in the U.S," said Societe Generale strategist Kit Juckes. 

"In other words, there`s a majority that thinks the bond sell-off isn`t over yet. It`s also, to a smaller extent, a bet that risk sentiment will survive the experience."