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Australia dlr gains, bonds buckle as market guns for rate hikes

SYDNEY, Oct 27 (Reuters) - The Australian dollar popped higher on Wednesday after a surprisingly strong reading on core inflation fuelled market wagers on early rate hikes and sent short-term bond yields to their highest since late 2019.

The Aussie added 0.4% to $0.7530 on the data and looked set to test the recent four-month top of $0.7546. Beyond that is the technically tempting 200-day moving average at $0.7560, while support lies at $0.7490 and $0.7454.

The New Zealand dollar lagged a little at $0.7165, but was still not far from its four-month top of $0.7219.

Yields on the cash three-year bond jumped 11 basis points to 0.907%, while the more liquid three-year future dived 18 ticks to 98.850 and lows not seen since mid-2019.

Trading in interest rate futures was patchy but were almost fully priced for a first hike in the 0.1% cash rate by July next year.

This was a direct challenge to the Reserve Bank of Australia (RBA) which has repeatedly argued that rates would not need to rise until 2024 given sluggishness in wages and inflation.

That stance might be harder to maintain given Wednesday’s data showed the trimmed mean measure of core inflation jumped to 2.1% in the third quarter. That was well above analyst forecasts of 1.8% and back within the RBA’s 2%-3% target band for the first time since late 2015.

It would also be a major surprise to policy makers who had thought core inflation would not reach 2% until mid-2023, though RBA Governor Philip Lowe has often emphasised he would need to see several quarters of inflation above 2% to contemplate an actual rise in cash rates.

“The rise in core inflation in Q3 was too broad based to write it off as temporary, and domestic demand is only likely to strengthen this quarter and next as the economy reopens from lockdowns,” said Su-Lin Ong, head of Australian fixed income strategy at RBC Capital Markets.

“On the other hand, it’s still hard to see wage growth get up to the 3% levels the RBA wants, which leaves them in a bind,” she added. “The market is going to keep pressing this and the RBA will have to defend it’s yield curve target.”

GUNNING FOR THE YIELD TARGET

The RBA is currently committed to keeping the yield on its target April 2024 bond near the 0.1% cash rate, but it was trading up at 0.21% after the inflation news.

The central bank responded last week by buying A$1 billion ($746.40 million) of the bond and taking its share of the issue to around 60%, but will be under pressure to buy more at its regular operation on Thursday or risk a significant rise in yields.

David Plank, head of Australian economics at ANZ, said the yield target (YT) was crucial to the RBA’s forward guidance policy.

“If the RBA continues to see the first move in the cash rate as being in 2024 then the Apr-24 target will remain in place, until it effectively ‘fades’ away,” Plank said in a note.

“We think the RBA will retain the target at next week’s Board meeting,” he added. “If the RBA brings forward its timing for the first hike, we think it likely the YT will be dropped, though an alternative is to also bring it forward.” ($1 = 1.3398 Australian dollars) (Editing by Christian Schmollinger)

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