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The Reserve Bank of Australia (RBA) is widely anticipated to raise interest rates by 25 basis points on Tuesday, a decision that, on balance, is unlikely to spark fireworks in the Australian Dollar.

But what if the RBA goes bigger, or smaller than what is expected?

Such a surprise would tend to trigger volatility in the Australian Dollar and according to analysts at BMO Capital Markets, there is a 35% chance of such an outcome.

"We think there is a chance that the RBA surprises with a rate hike bigger than 25bps. We also think there is a small chance that the RBA surprises with only a 15bp rate hike," says Stephen Gallo, European Head of FX Strategy at BMO Capital Markets.

The RBA could go for a larger-than-expected hike because it does not meet in January.

"The RBA justified hiking so much slower than its peers by noting that it meets more frequently, but for the next 2-3 months, that isn't really true due to the gap. A bigger hike here (say 40 or 50bps) would prevent the gap between itself and other key central banks (Fed, ECB, RBNZ, BoC) from widening as much," says Gallo.

He says a 40bp hike would get the RBA back on a precise quarter-point interval and "the year's end seems like the best spot to do that".

The bank could however get to a precise quarter-point interval by hiking 15bps this time.

Ahead of the weekend foreign exchange markets were in fact priced for such a move.

BMO Capital attaches a 10% probability to a 15bp rate hike and a 25% probability to a 40-50bp rate hike, with the remaining 65% probability assigned to a plain-vanilla 25bp hike.

With positioning in the Australian Dollar said to be relatively balanced, Gallo says the exchange rate should in theory respond in a normal fashion to the rate decision.

We read this as suggesting an Aussie Dollar rally on a bigger-than-expected hike and a decline on a smaller-than-expected hike.

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