Australian Dollar's "Upside Potential Curbed": Intesa Sanpaolo

• Near term pressures on AUD build
• AUD/USD weakness to keep GBP/AUD supported
• Longer-term AUD to rally

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The Australian Dollar will struggle to push GBP/AUD below the floor at 1.72 if the expectations at a major European lender and financial services provider prove correct.

Analysis from Intesa Sanpaolo finds that the Australian Dollar's upside potential will likely be curbed over coming weeks, meaning the Pound to Australian Dollar exchange rate might remain supported above the 2022 low located at 1.7180, reached just last week.

However, over a longer-term timeframe the Aussie Dollar can be expected to rally in a more robust fashion.

Asmara Jamaleh, Economist at Intesa Sanpaolo, says a combination of factors including Reserve Bank of Australia monetary policy, the war in Ukraine and the Chinese economic growth slowdown all make for a more cautious outlook.

"Risks to the forecast scenario are slightly skewed downwards, i.e. the Australian dollar could prove weaker than expected in the near term," says Jamaleh in a recently released research note.

Above: "AUD exposed to risks to global growth and to the resulting increase of risk aversion" - Intesa Sanpaolo.

The Australian Dollar rallied from late February as the war in Ukraine triggered another rise in commodity prices, particularly those which Australia produces such as natural gas coal.

The commodity price gains further improved Australia's terms of trade, offering a fundamental support to the Australian Dollar.

The currency rose to 0.7661 against the U.S. Dollar, the Pound to Australian Dollar exchange rate meanwhile fell to a low of 1.7175.

But fast toward to April-May and the Aussie Dollar's rally has stalled, with the Pound to Australian Dollar exchange rate (GBP/AUD) finding support back above 1.72 and the AUD/USD has long capped out at 1.76.

In fact, AUD/USD has come under increasing pressure and has fallen right back to the threshold at 0.70, further reinforcing GBP/AUD support even as Sterling struggles.

A move below here in AUD/USD could further ease pressure on GBP/AUD and allow for more of a recovery to potentially build: therefore what happens to AUD/USD will matter greatly for the cross rate that is GBP/AUD.

Crucial to the Aussie Dollar's setback against the Dollar, and elsewhere, is the U.S. Federal Reserve's accelerated pace of monetary tightening.

The Fed hiked by 50 basis points last week and looks set to do so in a succession of upcoming meetings, creating a substantial benefit to owning U.S. Dollars for those seeking yield on capital.

But a stronger Dollar and the increased cost of borrowing dollars globally creates a significant headwind to global growth and the pro-cyclical Australian Dollar.

Intesa Sanpaolo holds a view the Reserve Bank of Australia will proceed with further rate hikes, offering potential support for the Aussie Dollar near-term.

But the pace of rate hikes will be less than the market assumes: the market expects a steep succession of hikes, with a point of arrival at the end of the year at between 2.75% and 3.00%.

However, Intesa Sanpaolo anticipates a more moderate cycle of increases than this, with a point of arrival at between 1.50% and 2.00%.

"The RBA’s blander overall policy normalisation compared to the Fed’s should help contain the potential appreciation of the AUD," says Jamaleh. (Set your own FX rate alert here).

A slowing Chinese economy forms another pillar to a view the Aussie Dollar might have reached a peak for 2022.

China continues to pursue a zero-Covid policy that has materially impacted on domestic demand while hampering throughput of goods at the country's main ports.

In its May Statement on Monetary Policy the RBA lowered its economic growth expectations for the domestic economy in part on the significant uncertainty relating to the evolution of the pandemic picture in China.

"The Australian dollar could weaken further in light of the Fed’s steeper hike path compared to the RBA, and of the significant uncertainty still weighing on the global growth outlook in function of the evolution of the pandemic picture in China," says Jamaleh.

Intesa Sanpaolo's forecasts for the Australian dollar against the U.S. Dollar are at 0.69, 0.72, 0.75, 0.78, 0.80 on a one month, three month, six month, 12 month and 24 month horizon.

"Risks to the forecast scenario are slightly skewed downwards," says Jamaleh.

He says the Australian Dollar could prove weaker than expected in the near term, particularly so on a one month horizon, "when uncertainties at the global level will be at their highest".

"Beyond the near term, on the other hand, risks are skewed slightly upwards, i.e. the Australian dollar could prove stronger than expected, in particular in the event of the RBA opting for a steeper rate hike path, closer to the one currently priced in by the (futures) market," says Jamaleh.