Australian Dollar Outlook: This is No Game-Changer

The Australian dollar exchange rate complex has moved higher, however one analyst tells us he still sees the AUD trending lower.

Everything is essentially unchanged when comparing last month’s and August's RBA decision and ensuing statement - the cash rate remains at 2%, global financial conditions are accommodative, Australia’s economy is operating with spare capacity, and inflation will remain within the target zone over the next few years.

The RBA did however drop the reference to the Australian dollar needing to fall further in the Statement following the monthly Board meeting. This had the almost predictable result of helping to unravel all the Bank's previous work on the exchange rate as the AUD is the out-performer at the present time.

Meanwhile news that house prices on the east coast of Australia continue to stimulate economic activity will likely provide additional strength to the Aussie dollar for now.

Exchange Rates to Reference

• Pound to Australian dollar exchange rate is at 2.1108 with bank payments being offered around 2.0517 and specialist transfers being closer to the market at 2.0855.
• Euro to Australian dollar exchange rate is at 1.4849.
• Australian to US dollar exchange rate is at 0.7388.
• Australian to New Zealand dollar exchange rate is at 1.1182.

Please note that the above quotes are taken from the wholesale spot markets; your bank will subtract a spread at discretion when delivering FX for payments. However, an independent provider will seek to undercut your bank’s offer, thereby delivering up to 5% more FX.

This is No Game-Changer

ANZ Research believe that it is highly unlikely that the RBA Board now suddenly feel that the Australian dollar is right where it should be or that it is at some ‘fair value’.

"More likely is that they believe that it is going to fall from here without their encouragement. This suggests that they are reasonably confident that the Fed will raise rates in the next few months and also may hint at some concerns around emerging market growth that they are not willing to voice explicitly at this stage," says Warren Hogan at ANZ Research.

Hogan and his team do not believe that anyone should read today’s statement as being bullish for the Australian dollar other than to say that it reinforces our view that the RBA is on hold for the foreseeable future (rather than likely to cut rates anytime soon).

China Keeps the Outlook Subdued

Despite the present spike in the Aussie dollar complex the longer-term outlook appears less certain. China remains a headache for those hoping for a higher Australian dollar exchange rate complex.

China has a problem, and therefore so does Australia.

“AUD/USD has been under some downward pressure of late because of a renewed round of concerns about the Chinese economy, the general downtrend in commodity prices, and what seems to be a deterioration in sentiment towards Australia,” says Richard Yetsenga at ANZ Research in Australia.

The collapse in Chinese equities has been an eye-opener - the decline has come to be the central risk to the global economic outlook at the current time.

“While the initial catalysts for selling stocks were structural in nature, the focus quickly became the weakness of China's growth,” notes Peter Rosenstreich at Swissquote Bank in Gland, Switzerland.

Worries over the Chinese economy resumed due to the surprising drop in the July “flash” PMI to a 15-month low and corresponding soft price sub-indices.

Incoming data suggests that without significant policy intervention, China will be unable to reach the official 7.0% 2015 GDP target.

What does this have to do with the Australian dollar though?

“China's massive housing construction is extremely commodity demanding. The two largest inputs copper and iron ore are also Australia's largest commodity exports,” says Rosenstreich.

The fall in global commodity prices has all but ended capital expenditure investment in Australia, making any outlook of an economic upturn unlikely.

The Reserve Bank of Australia has reacted by cutting interest rates to try and sustain the economy - lower interest rates = lower exchange rates as the advantage that investing money in this once high-yielding country is diminished.

However, due to strong housing prices so far (see more below), the RBA has held off signalling additional rate cuts despite economic headwinds - something that has allowed the Australian dollar to avoid an even worse sell-off.

Annualised growth in national house prices accelerated again in June and the RBA has stated that monetary policy must take into account overall financial stability.

As commodities have slumped, the RBNZ and BoC have eased their monetary policy with a direct aim of weakening their currency to revive export growth.

The RBA has a bit more room since the economic erosion has not been as unforgiving.

Markets are now pricing in less than a 50% chance of a rate cut over the next three meetings, however, additional China below trend growth could easily push Australia's economic outlook into the RBAs rate cut red zone.

This is a key risk to the Australian dollar’s outlook.

“We are bearish AUDUSD and target a challenge to 0.7190 uptrend channel support before a deeper extension of downtrend,” says Rosenstreich.

Falls in the AUD/USD will surely be mirrored by gains in GBP/AUD as the two currency pairs have been trending in similar fashion.

Yetsenga does however point out that the commodities which are most closely associated with Australia –- coal and iron ore -- have actually been relatively stable.

If iron and coal prices can start trending higher we could well see further stabilisation in some key AUD exchange rates.

Asia stocks declined across the board at the start of the new week as Chinese economic data showed more weakness.

China Caixin manufacturing PMI final (different from the official read which fell to a five-month low at 50.0) contracted to a 2-year low at 47.8 in July compared with flash estimates of 48.2 and down from 49.4 in June. The Shanghai composite fell -2.33% and Shenzhen declined 2.30%.

Sydney House Prices Rocket Higher

This morning’s CoreLogic RP Data house price data confirmed the recent outperformance of house prices in the two biggest states, but especially Sydney, where dwelling prices were up 18.4% y/y in July.

This means the median Sydney house price has now pushed passed the AUD1m mark for the first time.

Sustained housing activity on the east coast is doing a significant portion of the heavy lifting required to move the Australian economy away from a reliance on raw material exports.

However, there is a danger that the market could over-heat and with this in mind the RBA will likely shy away from any AUD-negative cuts in the near-term.

ANZ Research shows New South Wales continues to lead the charge in the non-mining recovery, followed by Victoria.

It is reported that both states are benefiting from the residential investment upswing, export services and financially stronger governments that have more capacity to ignite new infrastructure projects.

If these two states can continue the diversification charge, and other states follow suit, then we could well see the Aussie dollar decouple from its Asian fix.

Retail Sales Improve

Underpinning confidence in the Australian dollar further was a good reading from the retail sector.

Australian Retail Sales printed at 0.7% versus 0.5% eyed while the Trade Balance gap was slightly better at -2.9B vs. -3.0B eyed.

The strong consumer spending may have been driven by seasonal factors such as back to school sales, but was nevertheless a welcome sign that the economy remains in decent shape despite sharp cutbacks in mining sector.