Australian Dollar Forecast: GBP/AUD Down Near-Term, But Recover Towards Year-End Say Westpac

The Australian dollar (AUD) is expected to maintain an advantage over pound sterling through coming weeks but should ultimately trend lower towards year end taking the pair back above 2.0 suggest Westpac Institutional Bank in their latest assessment of the pair.

This June has seen the pound to Australian dollar exchange rate (GBP/AUD) has slipped back below the 2.0 area - a notable round number for those looking to transfer funds from GBP into AUD.

At the time of writing we note the pair is at 1.9440 and approaching what could offer some support to the recent declines - the 100 day moving average at 1.9290.

Buying interest could pick up here provided no referendum polling data is released that suggests the Leave vote may carry the day in June.

Those with payments in GBP/AUD will be seeing their bank account offer rates in the region of 1.8907 through to 1.8771 while independent providers are seen offering in the 1.9277 - 1.9141 area.

Near-Term Favours Australian Dollar Strength

This has been a year that has favoured the Aussie and were it not for the 20 cent surge in GBP/AUD from late April to late May the market looked all but set to test the 2014 fulcrum of 1.80.

However a sudden and sharp recovery then shaped up after the Australian dollar was hit by an unexpected interest rate cut at the Reserve Bank of Australia (RBA).

The move higher in GBP/AUD extended on a reduced risk premium on sterling as EU referendum polls showed the UK was intending to vote to stay in the EU on the 23rd June.

However, recent polls suggest it was premature to price out “Brexit” - something that has seen sterling slip back below 2.0 once again.

“We expect the pound to underperform major currencies ahead of 23 June, helping GBP/AUD extend its decline to around 1.92,” says a special note on the GBP/AUD outlook issued by Westpac Institutional Bank to clients.

The Australian dollar is forecast to enjoy further near-term support on the observation that a lack of urgency at the RBA for another interest rate cut.

Further, steadying commodity prices should also help AUD over the next month or so.

The June 7th meeting betrayed an RBA that is happy to sit back and allow the effect of the rate cut it delivered last month feed through into the economy, something that has supported the Aussie. Most analysts had been expecting a more pronounced warning that another rate cut was imminent.

This should buy the AUD bulls some time; the idea that an investor can borrow in sterling (base rate 0.5%) and invest it in an Australian dollar account (base rate 1.75%) remains a compelling one and explains why the superior interest rate levels in Australia have resulted in a stronger currency.

Of course the attractiveness of such a trade has been diminished by the volatility seen in recent weeks, and we would expect this to continue to be the case.

Pound Relief-Rally to Carry GBP/AUD Back to Long-Term Range

After 23 June, the Remain victory that markets expect, should produce a relief rally in the pound. Westpac believe this is likely to drive GBP/AUD back to around 2.00, still short of the late May highs.

Such a move would represent something of a return to ‘business as usual’ - if we look back at the data it appears that the 2.05-2.20 area is the favoured range for GBP/AUD since the Aussie dollar was floated in 1983:

GBP/AUD is only modestly below its long term average rate versus sterling as the 1.90-2.05 range accounts for almost 10% of daily closes since the 1983 AUD float.

“During Q3 16, GBP/AUD may well spend more time in the 2.05-2.20 range that has captured a hefty 20% share of trade since the AUD float, that is if the RBA cuts the cash rate in August,” say Westpac.

Westpac’s view for a higher GBP/AUD is therefore based on an assumption that the cash rate will be cut again.

“Our base case is another 25bp easing in August. However, the RBA’s statement in June, when it held steady as expected at 1.75%, was a little surprising. While noting that inflation is likely to remain ‘quite low’ for “some time”, there was no resumption of an overt easing bias. Markets now see an Aug cut as a 50/50 prospect,” says the note.

This suggests an element of doubt that the RBA will in fact cut - a good number of analysts have pointed out repeatedly that one rate cut by the RBA is typically followed up by a second cut.

Could it be different this time around and the RBA opt to cut just once in the cycle? If so, this could well keep a cap on the GBP/AUD’s expected advance.

Keep an eye on data then as any deterioration will likely confirm the expected cut. Australia’s data pulse (% of data stronger than the previous release in a rolling 8 week window) has been soft for most of this year, though is now showing signs of life.

Q1 GDP (3.1% y/y) was a high profile component of this recovery.

The RBA should be fairly confident that Australia’s economic growth pace will hold around the 3% y/y projected in the RBA’s May forecasts for end-2016.

Australian inflation is however one big question mark hovering over the outlook as the RBA’s May rate cut was attributed to the shockingly low inflation rate reported in late April.

At the June rate decision the RBA reiterated its concerns over inflation, noting that “inflation has been quite low and this is expected to remain the case for some time”.

The large downgrade to the RBA’s forecast inflation profile, where the average inflation forecast remains at or below the lower bound of the 2-3% target band for the entire forecast period, strongly suggests to us that the Bank will need to ease further.

“The lack of an explicit easing bias makes an August rate cut a much closer call than we had previously thought. That said, we continue to expect a further cut given the size of the downgrade to the Bank’s inflation forecasts and the fact that the mid-point inflation forecast remains at or below the lower bound of the 2-3% target band for the entire forecast period,” says Felicity Emmett at ANZ Research.

RBA and RBNZ Inspire Antipodean Rally

Both the RBA and Reserve Bank of New Zealand (RBNZ) left monetary policy unchanged this week.

Both the Australian dollar and New Zealand dollar moved notably higher as both central banks were less dovish on their assessment on the outlook, with some traders reading this as a sign that no further currency-negative interest rate cuts will be forthcoming from either institution again in 2016.

"We expect the AUD to strengthen further towards this year’s peak of around 0.78 AUD/USD in the coming weeks as carry trades are back in favour," says analyst Roy Teo at ABN Amro.

However, ABN Amro's view is that the RBA will cut the Official Cash Rate (OCR) by 25bp in August - something that is not fully priced in. Hence the AUD is forecast to decline to around 0.72 in the third quarter.

This reflects the view given by Westpac on GBP/AUD's recovery towards year-end.

The RBNZ meanwhile seems more concerned about house price inflation than the strength in the NZD, which remains stronger than justified given commodity export prices.

Tighter macro prudential tools are likely to be implemented later this year to address potential financial stability concerns arising from the housing market.

"The current strength in the NZD could extend to around 0.75 in the coming weeks. We maintain our view that the RBNZ is likely to resume their policy easing bias in August, though the risk has increased that it might be later if house price inflation remains elevated. Our year end NZD/USD forecast is 0.68," says Teo.