GBP/AUD Rate Outlook "Super Bearish" Over Medium-term

• Unraveling of latest GBP/AUD rally a matter of time
• Build up of speculative positions prone to a reversal
• UK's economy & high BoE interest rate another risk   

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The Pound to Australian Dollar exchange rate reached its highest level for more than three years earlier in August but its increasingly speculative rally faltered earlier this week and one trader says that betting on a further unraveling of the uptrend should pay off significantly sooner or later. 

Sterling sustained some of its largest intraday losses since the opening of July this week after business surveys poured cold water over the UK economic outlook and interrupted a steep 2023 climb in GBP/AUD that has most recently been accompanied by a significant build-up of speculative bets on the exchange rate. 

“You might want to go short GBPAUD because the extremes in positioning have coincided somewhat nicely with the extremes in the price of GBPAUD,” says Brent Donnelly, CEO at Spectra Markets and a veteran currency trader with a career spent between hedge funds and global banks such as HSBC and Nomura. 

“But the lags have been so long that there isn’t much of a signal unless you look out about a year. One year out, it’s super bearish. Here is a GBPAUD chart [below] tagged with the times that the GBP minus the AUD position was over +35% (currently +45%),” he writes in Tuesday’s edition of the am/FX daily macro newsletter. 

Source: Spectra Markets. 

GBP/AUD was still up more than 15% for the year on Thursday following a strong rally by Sterling and something close to relative underperformance from the Aussie, which has been bogged down by multiple headwinds including commodity prices, the Renminbi and the Reserve Bank of Australia (RBA) interest rate stance. 

“Commodity prices have weighed on AUD/USD and NZD/USD recently. China is the largest market for Australian and New Zealand commodity (and services) exports.  Commodity prices are falling in large part because the Chinese economy has stalled,” says Joseph Capurso, head of international economics at Commonwealth Bank of Australia.

China’s economic recovery from the ‘coronavirus’ restrictions phased out late last year has so far underwhelmed lofty financial market expectations and dampened demand for commodities around the world just as central bank monetary policies have increasingly marred the outlook for other parts of the global economy.

Australia’s international trade relationship with China has combined with an emerging gap between interest rates down under and elsewhere among advanced economies to disadvantage the antipodean Dollar relative to other currencies after the RBA indicated repeatedly that its interest rate cycle is close to being over.

“Markets are pricing the RBA cash rate, currently at 4.10%, to be unchanged in September, and to peak at 4.20% in March,” says Sean Callow, a strategist at Westpac. 

Above: Pound to Australian Dollar rate shown at daily intervals alongside AUD/USD. 

The RBA has attached a high priority to retaining the employment growth generated following the pandemic and to keeping the local economy on an even keel as it seeks to guide inflation back to the 2.5% target while interest rates for Sterling and some other currencies have reached their highest since before the 2008 financial crisis. 

“While our macro team's most updated call is that the RBA is done with hiking, they do note the risk of another 25bp hikes before the end of the year. Against this, AUD's one of the cheapest currencies on our dashboard,” says Alex Loo, a strategist at TD Securities, who advocated buying AUD/USD on Wednesday.

Ebbing inflation and so-far tame wage growth in the labour market are among the factors helping to keep the cash rate pinned down at 4.1% but wage settlements are rising and commodity price prospects would likely also improve with any eventual recovery of Chinese economic growth.

These are each examples of the kinds of things that could lead to a recovery in Australian Dollar rates more generally with adverse implications for GBP/AUD though the latter also faces risks from the Sterling side of the equation including a dimming UK economic outlook and a maturation of the Bank of England (BoE) interest rate cycle.

“We forecast AUD/GBP will hold onto its declines and remain heavy near 0.52 [GBP/AUD: 1.92] over the rest of this year. The prospect of interest rate hikes by the Bank of England (BoE) will remain a weight on AUD/GBP,” says CBA’s Capurso.

Above: Pound to Australian Dollar rate shown at weekly intervals.

“We consider market pricing of BoE hikes is too aggressive. While we expect an unwinding of BoE hikes, its positive impact on AUD/GBP may be offset by pricing of recessions in the US, the UK and several other major economies,” he adds.

The Bank of England now has the third highest interest rate and what has long been one of the slowest growing economies within the group of G10 economies, which makes the UK something of a canary in an economic coalmine and counts as another reason why the uptrend in GBP/AUD might be on borrowed time already. 

Hence why Wednesday's S&P Global survey results caused a stir when suggesting an ongoing downturn in the UK manufacturing sector deepened in August and that activity in the all-important services industry moderated enough to leave it close to a recession.

"Meanwhile, Sage reported sales at Britain’s small businesses have collapsed by a fifth," says Neil Wilson, chief market analyst at Finalto Trading and Markets.com. 

UK growth remained positive in the first half of 2023 but was close to zero while the size of the increase in interest rates since December 2021 suggests a high risk of recession.