Australian Dollar Bears Down on Sterling as Brexit and Bank of England Loom Over London

- GBP/AUD eyes six-month lows as April-to-May losses near -10%.
- Market distinction between GBP and commodity currencies fades.
- GBP/USD headwinds, AUD/USD tailwinds spell GBP/AUD losses.
- GBP eyes 1.8461 but risks 1.7122-to-1.7552 in a severe scenario.

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• GBP/AUD spot at time of writing: 1.8699
• Bank transfer rates (indicative): 1.8047-1.8178
• FX specialist rates (indicative): 1.8421-1.8534 >> More information

The Pound-to-Australian Dollar rate is on the back foot again this week and set to test a six-month low as Sterling's run of underperformance continues while the antipodean unit remains a star player in the major currency barrel. 

Sterling is increasingly a problem child of the major currency universe and the Aussie a prefect, which neatly explains the -9.93% fall seen by the Pound-to-Australian Dollar rate between the beginning of April and Wednesday's session.

The rub for Sterling is that further losses are almost certainly in the pipeline and a return to 2019 lows or worse cannot be ruled out for the Pound-to-Australian Dollar rate in the coming weeks. 

"We have been fearful of the shallowing of the risk recovery, however during this time the Aussie has still been a standout performer. With a more positive risk appetite taking hold this week, the Aussie has outperformed," says Richard Perry, an analyst at Hantec Markets. 

The Pound-to-Australian Dollar rate has fallen nearly -1.5% to test below the 1.87 handle this week amid a rebound in risk assets, including stocks and commodities, that has roots in U.S. biotech firm Moderna's claim to have made progress on a coronavirus vaccine. That and a steady reopening of some economies including Australia's has stoked investors' appetites for risk and lifted the commodity sensitive Australian Dollar while pressuring GBP/AUD. 

Above: Pound-to-Australian rate at daily intervals with key moving-averages and Fibonacci retracements of 2020 fall.

Sterling's problem though is that when the market has a bad day the above relationship no longer necessarily goes into reverse, which is a change in behaviour for the British currency that's been well illustrated since the coronavirus closed the global economy. This is a problem because it potentially condemns the GBP/AUD rate to further losses whatever the proverbial weather. 

"GBP has been undermined in part by more challenging conditions for risk assets over the past week, but weakness this month appears to be driven by GBP specific negative factors as well. It is notable that other high beta G10 currencies such as the AUD have still performed well this month. GBP/AUD has fallen by -2.5% month to date," says Lee Hardman, a currency analyst at MUFG, in a research note. "Risks to the GBP from heightened Brexit uncertainty could return as well in the coming weeks and month ahead. A lack of progress in trade talks has increased the risk of an unfavourable outcome from the EU-UK Summit scheduled for next month. The UK government has previously threatened to walk away if a broad outline agreement has not been reached."

In theory, a run of bad days for risk appetite could drag AUD/USD back to 0.60 from 0.6545 Wednesday if the going got really tough, which would lift the Pound-to-Australian Dollar rate as far as 2.0 if GBP/USD was somehow able to limit its decline to 1.20.

However, there's no obvious reason why Sterling would decline by only 2.5 cents in an environment where the Aussie has fallen by five cents, especially after last week's performance.

The Pound-to-Aussie rate can be viewed as an amalgamation of GBP/USD and AUD/USD, and last week saw it decline steadily despite a fresh bout of risk-aversion in global markets, which would typically have benefited the British currency at the expense of its antipodean counterpart.

But GBP/AUD dipped in line with the fall in stocks, demonstrating in the process investors' lesser distinction between Sterling and typically riskier commodity currencies like the Aussie. 

This was because GBP/USD suffered more than AUD/USD even before Friday's jarring update from Brexit negotiators that confirmed another deadlock just weeks out from a key July 01 deadline, which underlines that lesser distinction between the Pound and the riskiest of major currencies.

"After being set aside due to Covid-19 related risks, the Brexit debate has come back in focus, with increased uncertainty around the year-end transition deadline. June 18-19 (EU Council Meeting) and July 1 (Formal deadline for Transitions extension) are important dates to clarify whether the transition period will be extended. If PM Johnson doesn't ask for an extension, as our economists expect, obstacles to Brexit negotiations are likely to escalate and add to uncertainty over the next 6m," says Alessio Rizzi, a portfolio strategy associate at Goldman Sachs. "FX is usually the clearest representation of UK Political risk, together with UK Domestic exposed stocks vs. the FTSE 100."

Above: AUD/USD rate at daily intervals with S&P 500 stock index (black line) and GBP/USD rate (orange line).

There are lots of reasons for why the market now sees a lesser distinction but what might matter more to the outlook is that some of the drivers of Sterling's underperformance are widely expected to become more pressing in the weeks ahead. The Bank of England (BoE) has all but said it will increase its quantitative easing programme in June while the BoE's chief economist revived the possibility of a shift to negative interest rates at the weekend.

These Sterling-negative monetary policy developments will be playing out just as the market catches a glimpse of July's Brexit-shaped cliff edge that's also expected to begin weighing on the Pound in weeks ahead. Those factors are contributing to a GBP/USD outlook that has come decidedly bearish just as the AUD/USD rate recovers the entirety of its coronavirus-related loss and threatens to break out in the direction of pre-virus highs. That should mean trouble ahead for the Pound-to-Australian Dollar rate 

Above: AUD/USD rate shown at daily intervals with key moving-averages and Fibonacci retracements of 2020 downtrend.

"AUD/USD bounced off the .6403/.6374 current May lows and is well placed to tackle the .6570 April high. Above .6570 we look for a test of the .6663/84 March high and 200 day moving average where we would expect it to struggle. Above here would target .6910, the 2013-2020 resistance line," says Karen Jones, head of technical analysis for currencies, commodities and bonds at Commerzbank. "GBP/USD continues to stabilise slightly above the 50% retracement of the March-to-April advance at 1.2030 below which lies the minor psychological 1.2000 mark. Further down sit the September low at 1.1958 and the March 20 high at 1.1935. A drop below there is needed to refocus attention on 1.1491, the 2016 low, and also on the March low at 1.1409."

The GBP/USD rate has attempted to stabililse early this week but Commerzbank's Jones and many others look for a decline back toward 1.20 in the days and weeks ahead, which would send the Pound-to-Australian Dollar rate down to 1.8461 if the AUD/USD rate remains around Wednesday's 0.65. Pound Sterling Live flagged that level as a likely destination for the GBP/AUD in an April editorial, although it might prove too optimistic if the AUD/USD rate continues its nascent march to the upside. 

Above: GBP/AUD rate at weekly intervals with moving-averages and Fibonacci retracements of post-referendum recovery.

However, the above rates would only available be at interbank level with those quoted to retail and SME participants likely much lower. Specialist payments firms can help squash the spread between interbank and retail rates.

"Australia is earlier to relax its lockdowns with much lower growth in virus cases than that of the UK, it stands to benefit more from the coming Chinese stimulus than the UK and GBP/AUD is showing signs of trending lower in a G10 FX market that is currently very range bound," says Jordan Rochester, a strategist at Nomura, in an early May research note that advocated the bank's clients sell the Pound-Australian Dollar rate around 1.94 and look for a move down to 1.86. 

An AUD/USD rate that tests 0.6663 would send the Pound-to-Australian Dollar rate to 1.80, its lowest since September 2019, in a market where GBP/USD is back at 1.20. Sterling's losses would be even steeper if GBP/USD returns to the March low of 1.1409 seen by Jones as a likely target for the next three months, if AUD/USD remains between 0.65 and 0.66 concurrently.

That latter scenario would see GBP/AUD trading between 1.7122 and 1.7552, levels seen only briefly in December 2018 and before that, in the immediate aftermath of the 2016 Brexit referendum. It would take an AUD/USD decline back to 0.61 to prevent the Pound-to-Australian Dollar rate falling below Wednesday's 1.8700 in a world where the GBP/USD rate is trading at 1.1409.