Can Rising Inflation Expectations Reverse the Australian Dollar's Losing Streak?

The Australian Dollar has extended its decline against the US Dollar for the sixth consecutive trading day, reflecting a complex interplay of domestic hawkish signals and global monetary policy divergence. Despite growing market expectations for an RBA rate hike as early as February, the Aussie continues to struggle against USD strength, raising questions about what it would take to stabilize the currency.

Inflation Pressures Fuel Rate Hike Expectations

Consumer inflation expectations in Australia climbed to 4.7% in December, up from November’s three-month low of 4.5%, signaling persistent price pressures that support the Reserve Bank of Australia’s increasingly hawkish stance. This uptick reinforces the view that sticky inflation remains entrenched within Australia’s capacity-constrained economy, prompting major financial institutions to revise their rate-hike forecasts forward.

Both Commonwealth Bank of Australia and National Australia Bank have accelerated their expectations for when the RBA will begin tightening policy. Following the central bank’s hawkish hold at its final 2025 meeting, market pricing now reflects a 28% probability of a February rate hike, with March odds climbing to nearly 41%. By August, the market has nearly fully priced in an increase, suggesting a multi-month tightening cycle is anticipated.

For Australian Dollar holders considering currency conversions—where 25 Australian dollars in pounds would translate to roughly 13 pounds depending on exchange rates—these inflation dynamics represent a critical factor shaping future currency direction.

US Dollar Gains as Fed Cut Expectations Cool

The US Dollar Index, which measures the greenback’s strength against six major currencies, is holding firm near 98.40, buoyed by diminishing expectations for further Federal Reserve rate cuts. This shift reflects a broader reassessment of US monetary policy trajectory, driven by mixed economic signals from across the Atlantic.

Recent labor market data tells a nuanced story. November’s jobs report showed payroll growth of 64,000, marginally above forecasts, yet October’s figures were significantly revised lower, and the unemployment rate ticked up to 4.6%—the highest level since 2021. Retail sales remained flat month-on-month, underscoring softening consumer demand.

Atlanta Fed President Raphael Bostic acknowledged this mixed picture in a recent blog post, suggesting the jobs data did not fundamentally alter the Fed’s outlook. Notably, Bostic emphasized that price pressures extend beyond tariff impacts, warning against premature declarations of victory on inflation. He projects 2026 GDP growth at approximately 2.5%, implying a measured approach to additional easing.

Fed officials remain divided on whether 2026 warrants further rate reductions. Median Fed projections call for just one cut next year, while some policymakers see no additional reductions needed. Market participants, however, anticipate two rate cuts, creating a disconnect between official guidance and trader positioning. The CME FedWatch tool currently prices an implied 74.4% probability of unchanged rates at the January Fed meeting, up from 70% a week prior.

China’s Economic Slowdown Adds Headwinds

Weakness in China’s economic performance is exerting additional pressure on commodity-linked currencies like the Australian Dollar. November’s retail sales grew just 1.3% year-over-year, missing the 2.9% forecast, while industrial production expanded 4.8% versus the 5.0% expected. Fixed asset investment disappointed further, arriving at -2.6% year-to-date versus the -2.3% estimate.

This economic softness in China, Australia’s largest trading partner, compounds concerns about the medium-term outlook for Australian exporters and supports continued USD strength as investors seek exposure to more resilient economies.

Mixed Manufacturing Signals from Australia

Australia’s preliminary S&P Global Manufacturing PMI edged higher to 52.2 in December from 51.6 previously, providing modest encouragement. However, the Services PMI retreated to 51.0 from 52.8, while the Composite PMI declined to 51.1 from 52.6. These readings suggest economic growth remains modest and uneven across sectors.

Employment data released last week by the Australian Bureau of Statistics showed the unemployment rate holding steady at 4.3% in November, slightly better than the 4.4% consensus. However, employment fell by 21,300 in November after rising 41,100 the previous month (revised), disappointing expectations of a 20,000 gain. This volatility raises questions about labor market durability heading into 2026.

Technical Breakdown: Where Are the Support Levels?

From a technical perspective, the AUD/USD pair is trading below the critical 0.6600 support zone, having slipped beneath its nine-day exponential moving average. The pair has also moved below the ascending channel trend that previously defined the bullish bias, signaling a shift in near-term momentum.

Key support levels warrant close monitoring. The psychological barrier at 0.6500 looms as the next target, with the six-month low of 0.6414 (set on August 21) providing deeper support. Should the Aussie stabilize, resistance levels include the nine-day EMA at 0.6619, followed by the three-month high of 0.6685 and 0.6707 (the highest level since October 2024). A sustained rebound would target the upper ascending channel boundary near 0.6760.

Outlook: Rate Hike Priced In, But USD Still in Command

The paradox facing the Australian Dollar is clear: while RBA rate hike expectations are rising and inflation remains sticky, USD strength continues to overwhelm bullish AUD fundamentals. The divergence between an increasingly hawkish RBA and a cautious Federal Reserve—which is unlikely to cut rates soon despite soft data—suggests USD strength may persist in the near term.

The AUD/USD pair’s technical breakdown indicates further downside risk, with 0.6500 appearing vulnerable. Recovery would require either a significant shift in Fed policy expectations or a marked improvement in China’s growth momentum. Until one of these catalysts emerges, the Australian Dollar is likely to remain under pressure despite the improving case for higher rates down under.