Australian Dollar to Outperform Pound and U.S. Dollar in 2023 say Analysts

• GBP/AUD could fall below 1.70: Rabobank
• UBS sees AUD/USD upside over coming months
• "We expect AUD/USD to outperform" - Barclays

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2023's top-performing major currency can continue to deliver upside against the Pound and U.S. Dollar according to analysts who believe a strong economy will receive additional support from China's improved growth potential.

"Aussie data supports our long AUD view," says Thomas Flury, Strategist at UBS.

The analyst says the view is emboldened by recent figures that reveal inflation is running hot and consumers remain willing to spend.

The Australian Dollar cemented its 2023 outperformer status on January 11 when it was reported headline CPI inflation increased by 7.3% year-on-year in the final quarter of 2022, which was ahead of consensus expectations for 7.2% and up on the previous quarter's 6.9%.

Data also showed retail sales rose 1.4% month-on-month in November, far ahead of expectations for 0.6% growth while previous estimates were revised materially higher.

"These data have strengthened expectations of another 25 bps rate hike from the RBA next month and pushed back of talk that the central bank could be on the cusp of a policy pause," says Jane Foley, Senior FX Strategist at Rabobank.

These domestic data suggest to analysts that the Reserve Bank of Australia (RBA) will be required to maintain its tightening bias for longer than it has advocated in recent policy communications.

A higher terminal rate for the RBA's cash rate target is consistent with additional support for the Australian Dollar via the interest rates channel, particularly against currencies belonging to central banks that are on the cusp of ending their own cycles.

The Australian Dollar could gain against the U.S. Dollar and British Pound in particular, given both the Federal Reserve and Bank of England are poised to end their hiking cycles during the first quarter.

Above: Australian retail sales, image courtesy of Westpac.

Interest rates matter greatly for Aussie Dollar performance as the currency rose above 1.0 against the U.S. Dollar and pushed GBP/AUD below 1.50 in the early 2010s amidst a global commodity boom.

But fast-forward to 2022 and the Australian Dollar was at significantly cheaper levels, despite another commodity boom.

The difference between 2022 and the early 2010s was interest rates: Australia offered significantly higher rates than elsewhere, underscoring demand for the currency.

Rates at the RBA won't rise back to 4.75% in this cycle, but a lifting of the terminal rate from previous expectations still provides a supportive fundamental development from a currency perspective.

"We view the AUD as less likely to be swayed by speculative flows given that Australia no longer had a current account deficit and given that the narrowing of interest rates spreads between Australian and US interest rates," says Foley.

Above: Long-term view of GBP/AUD. Consider setting a free FX rate alert here to better time your payment requirements.

UBS meanwhile says the cumulative 50bps priced in for the RBA over the next four meetings could be too low.

"This — plus rising optimism stemming from China's reopening and improving bilateral relations — indicates upside potential for Australia’s goods and services exports over the coming months," says Flury.

The reopening of the Chinese economy in late 2022 and early 2023 has led economists to expect growth in the world's second-largest economy will get back to its full potential sooner than had previously been expected.

This is supportive of Chinese proxies, such as the Australian Dollar, as well as overall global growth and sentiment.

The Australian Dollar's prospects have also been boosted by an apparent thawing of political tensions between China and Australia following a change in government.

Renewed diplomatic contacts with a view to improving relations have already culminated in a loosening of the ban on Australian coal, which would further aid Australia's booming export sector, a key fundamental source of support for AUD.

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Under former Prime Minister Scott Morrison relations steadily deteriorated, with a low being reached when Morrison called for an inquiry into the role of Chinese authorities in the origins of Covid-19.

In response, China banned some Australian exports, such as coal, barley, wines, timber and some foods.

"In recent weeks there have been signs of a loosening of the ban on Australian coal. This, combined with hopes of a return of Chinese tourists and students to Australia, has helped support expectations that Australia will steer clear of recession in the foreseeable future," says Foley.

Reports also suggest the improvement of relations and the loosening of travel restrictions have resulted in a boost to enquiries by Chinese citizens for places in Australian universities.

"Tourism, education and property sectors in Australia could benefit if relations between China and Australia start to warm up. This is positive for AUD. Not forgetting China reopening story and Fed policy calibration thematic that can further add to long AUD bias," says Christopher Wong, FX Strategist at OCBC Bank.

Above: Australia's trade surplus remains robust, providing a fundamental source of support to the Aussie Dollar. Image courtesy of Westpac.

The warm sentiment to the Aussie means the Pound to Australian Dollar exchange rate (GBP/AUD) has already fallen 1.30% in January as it adds to a 4.75% loss recorded in 2022, and Rabobank expects 2023 to see another annual decline for the pair.

"We expect the AUD to be well supported this year on the back of a relatively good growth outlook and have been targeted a move by GBP/AUD below 1.70 on a 12 mth view," says Foley.

The Australian Dollar meanwhile fell 6.0% against the U.S. Dollar in 2022, but a number of analysts are of the view 2023 will see the tables turned.

Indeed, UBS strategists "remain positive" on the Australian Dollar's prospects, forecasting AUD/USD to be in the mid-high 70s by the second half of 2023.

"We expect AUD/USD to outperform, drawing on rising optimism around a China recovery," says a currency research briefing from Barclays. "Reports indicating that China is considering resuming imports of Australian coal likely boosted sentiment and reinforced expectations of China-related tailwinds."