Aussie as a proxy of China

A bit of surprise rippled through the markets yesterday, which looks like coincided with a similar event in late October. Reserve Bank of Australia unexpectedly decided to raise its official interest rate by 25bp to 4.75% at the monetary policy meeting, where most analysts predicted it to be held steady. Rattled currency markets made the Australian dollar shoot up to around parity with the US dollar.

RBA explained the reason for rate hike is that

the economy is now subject to a large expansionary shock from the high terms of trade and has relatively modest amounts of spare capacity. Looking ahead, notwithstanding recent good results on inflation, the risk of inflation rising again over the medium term remains.

Australia has set an inflation target of 2-3% not to "materially distort economic decisions in the community." The core CPI has recently increased by 3%, an upper limit of the inflation target. Given that the terms of trade has hit all time high, RBA's decision to raise the interest rate is considered to be preemptive in terms of curbing inflationary pressure.

Note that China also raised the interest rates suddenly late last month, which plunged world stock markets and appreciated the US dollar as a safe haven in fear of China's economic slowdown. RBA, though, interpreted the largest trade partner's action differently, saying in the statement that "concerns about the possibility of a larger than expected slowing in Chinese growth have lessened recently." China's policy would have stirred RBA to concentrate more on inflation than economic condition.

It wouldn't be ridiculous to trade the Australian dollar as a proxy of the yuan.