Pound-Australian Dollar Rate Hits 1.80 as RBA and BoE Diverge

- GBP/AUD hits new two-month high
- RBA and BoE divergence underpin rally
- Upside could be limited by recovery in iron ore prices

Above: File image, Governor Lowe delivers RBA assessment, copyright Pound Sterling Live.

• GBP/AUD spot rate at publication: 1.7982
• Bank transfer rates (indicative guide): 1.7350-1.7470
• FX transfer specialist rates (indicative): 1.7560-1.7800
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The jump in Pound Sterling's value following Thursday's Bank of England event combined with a dovish message from the Reserve Bank of Australia to trigger a new two-month high in the Pound-to-Australian Dollar exchange rate (GBP/AUD).

Buyers of Australian Dollars saw the best exchange rates on offer since December 10 after Reserve Bank of Australia (RBA) Governor Philip Lowe continued to hammer home the message that Australian interest rates will not be rising soon.

Lowe told lawmakers that the outlook for the Australian economy has improved but interest rates will remain low for a while.

He said the RBA was unlikely to raise interest rates until at least 2024 as employment and inflation remain well short of target.

The message should keep ensure the yield paid on Australian Government bonds remains as low as possible for a while yet, thereby ensuring the cost of borrowing in the Australian economy stays at levels supportive of economic growth.

"This morning's RBA Statement on monetary policy hasn't sent the AUD flying, despite being upbeat. The reason: The RBA is committed to an extended period of easy policy," says Kit Juckes, an analyst at Société Générale.

Also driving yields lower is the RBA's quantitative easing programme, whereby the Bank enters the open market to snap up government bonds, creating a demand that simultaneously lowers the yield paid out on those bonds.

Lowe's comments follow Tuesday's decision by the RBA to boost its quantitative easing programme that will see the Bank purchase a further A$100BN worth of bonds, to be delivered from mid-April at a pace of around A$5BN per week.

While lower yields are supportive of the economy they also tend to weigh on the Australian Dollar as lower yields are unattractive to foreign investors who will instead look for better returns elsewhere; therefore the message from Lowe is consistent with a weaker Australian Dollar.

Contrast this with the Bank of England (BoE) who on Thursday said staff had been instructed to work on guidance about the appropriate strategy for tightening monetary policy, i.e. less quantitative easing and higher rates in the future.

So on the one hand the RBA is really pushing back against the idea of higher rates and on the other the BoE is hinting that higher rates lie ahead, creating a divergence has helped pull the GBP/AUD exchange rate higher:

Above: GBP/AUD's 2021 uptrend.

And the impetus behind the move higher in Sterling against the Aussie Dollar could extend, according to one noted analyst.

"The two currency pairs to watch for are GBP/AUD, GBP/NZD," says Vincent Poon, Head of FX & FXO Sales at CIBC Bank, "both have broken topside trendlines."

The British Pound built a new head of steam on Thursday after the BoE's Monetary Policy Committee (MPC) voted unanimously to maintain Bank Rate at 0.10%, and to maintain the Asset Purchase Programme (quantitative easing) target at £895BN.

While the decision was expected a significant number of participants in the market were expecting the vote to be closer, and/or for quantitative easing to be extended.

Indeed, one noted investment bank said they were expecting the Bank to cut interest rates and boost quantitative easing.

Therefore the final decision had enough of the surprise element to it to move the Pound, given the market's caution heading into the event.

Money markets are now no longer pricing in negative rates in 2021, whereas going into the event negative interest rates were expected in the second half of the year.

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The 'pricing out' of negative rates in the medium-term had the effect of taking Sterling higher alongside.

On the matter of negative interest rates in the future, economists are of the view that it would require a notable deterioration in UK economic performance and sentiment before such a move was taken.

The BoE said it was "appropriate" to begin preparatory work with UK banks to enable a negative Bank Rate to be implemented, but the BoE "did not wish to send any signal that it intended to set a negative Bank Rate at some point in the future".

For now relative monetary policy between Australia and the UK is swinging behind the Pound, but readers must be aware that the Australian Dollar derives value from other sources, particularly Australia's commodity exports.

We have noted how the Australian Dollar's recent decline has a lot to do with the decline in the value of iron ore, which is the country's premier export and foreign exchange earner.

Iron ore price dynamics are in turn largely driven by demand out of China, and foreign exchange markets will therefore keep a close eye on the Chinese economy and its post-covid stimulus programme when trying to predict the Australian Dollar's outlook.

Should iron ore prices start rising once again, the Australian Dollar could find itself better supported and questions will be asked by investors of the GBP/AUD exchange rate's uptrend.