Pound / Australian Dollar Rate Slides as RBA’s Policy Shift Brings 1.70 into View

• GBP/AUD slide could extend to 1.7030 short-term
• After RBA hints it could meet market expectations
• With suggestion cash rate may soon begin to rise
• After wages & inflation show signs of acceleration
• Revives rally in AUD/USD, bringing 0.77 into view

Image © Newtown Grafitti, Reproduced under CC Licensing.

The Pound to Australian Dollar exchange rate fell to four-year lows early in the new week and could be at risk of slipping further toward 1.70 over the coming days after the Reserve Bank of Australia (RBA) indicated that it could, after all, meet market expectations for its interest rate.

Australia’s Dollar extended an eight-week long rally against the U.S. Dollar, Sterling and other currencies on Tuesday after the RBA omitted from its April policy statement an earlier piece of guidance suggesting the bank would be patient before lifting its cash rate, which was left at 0.10% this week.

“The Governor has significantly changed his language in the Statement to allow flexibility to start raising rates based on data “over coming months”. By definition, that could be as early as June, which would be two months earlier than our current call,” says Bill Evans, chief economist at Westpac. 

The RBA noted that Australian inflation and wages growth has been picking up steadily in recent months, which have long been marked out as prerequisites for any eventual increase in Australia’s benchmark interest rate, which was cut to a new low of 0.10% back in March 2020.

Above: Pound to Australian Dollar rate at daily intervals and shown alongside pread, gap or differential between 02-year UK and Australian bond yields. Click image for closer inspection.

"Given the tightness of the labour market, a further pick-up in aggregate wages growth and broader measures of labour costs is in prospect. This pick-up is still expected to be only gradual, although there is uncertainty about the behaviour of labour costs at historically low levels of unemployment," Governor Philip Lowe said in a Tuesday statement.

"Over coming months, important additional evidence will be available to the Board on both inflation and the evolution of labour costs. The Board will assess this and other incoming information as it sets policy to support full employment in Australia and inflation outcomes consistent with the target," he added.

Until now the RBA’s guidance had suggested it would likely be some time, and quite possibly the end of 2024 before its cash rate begins to rise from the pandemic-inspired low of 0.10%, although Tuesday’s statement opened the door to an interest rate rise that could come as soon as June.

“The RBA has been making small steps towards becoming less dovish in the past couple of months and the tone of this morning’s policy statement has added to the market’s perception that the RBA could be hiking rates in the not too distant future,” says Jane Foley, head of FX strategy at Rabobank.

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“AUD/USD has jumped higher overnight on the back of the RBA meeting and subsequently breached our 0.76 medium-term target for the currency pair. Consequently we are pushing up our forecast to AUD/USD 0.78 by year end,” Foley also said on Tuesday. 

The Australian Dollar rallied broadly on Tuesday but could advance further in the short-term if the pending RBA’s policy shift leads a recently bearish market to abandon the large ‘short position’ built up against the Aussie over the last year.

"With the economy performing strongly and a recent additional boost from higher commodity prices, that the bank is now preparing to hike completes a suite of factors supporting further strength in the AUD, beyond that already seen," says Patrick Bennett, head of Asia FX strategy at CIBC Capital Markets.

"We had looked to be buyers of weakness in AUD/USD on a possible pullback below 0.7500. Given the strength of the move today, a pullback to 0.7550-60 may be the limit of any retrace," Bennett and colleagues said on Tuesday.

Above: AUD/USD shown at weekly intervals with Fibonacci retracements of May 2021 fall indicating possible areas of technical resistance for the Aussie. Click image for closer inspection.

Australia's Dollar was one of the most heavily sold major currencies in 2021 and entered this year as the market’s largest ‘short,’ in part because the RBA had suggested it would likely continue to lag behind other central banks.

Central banks across the world are increasingly withdrawing pandemic era monetary policy support for their economies due to sharp increases in inflation, which far exceeds targeted levels in many instances, and the risk that it could remain above target for an extended period.

“CBA continues to forecast a June rate hike to 0.25%, with risks of a move in May if the CPI is strong enough. The market pricing seems to largely gel with this,” says Martin Whetton, head of fixed income and currency strategy at Commonwealth Bank of Australia. 

“The market is pricing a cash rate of around 0.35% for June. Although it’s tempting to say that’s suggesting a good prospect of a 50bp move to start the cycle, we think the correct interpretation is actually that the market is giving, roughly, a 50% chance of a hike in May followed by a hike in June,” Whetton and colleagues said in a research briefing on Tuesday.

While financial markets have largely priced-in the anticipated cycle of interest rate rises likely to be seen in Australia, any reversal of the market’s large short position would be an upside risk for the Australian Dollar and a potential source of ongoing pressure on GBP/AUD over the coming days.

Above: Pound to Australian Dollar exchange rate at weekly intervals with Fibonacci retracements of 2017 rally indicating possible-areas of medium-term support for Sterling, and shown alongside selected moving-averages. Click image for closer inspection.