Australian Dollar too Expensive warn Westpac (and RBA Governor Debelle Appears to Agree)

The Australian Dollar has been dealt a reality check by the Reserve Bank of Australia which is clearly not happy with the currencies recent rise.

Ahead of the appearance of Deputy Governor Guy Debelle on Friday, we wrote "the Aussie Dollar might be getting a little ahead of itself here," citing a number of analysts who believed the exchange rate was now entering expensive territory.

And on cue, Debelle says in Adelaide, "just as the policy rate in Australia did not need to decline to the very low levels seen in other parts of the world, the fact that other central banks increase their policy rates does not automatically mean that the policy rate here needs to increase."

The Australian Dollar took a hit on the comments and faded recent strength against Sterling, the US Dollar and Euro.

Why the Aussie Needs to Calm Down

The Australian currency is now this year’s best-performing major currency in the group-of-ten of the world’s largest currencies.

This is where the currency stood relative to others ahead of the Debelle speech:

It’s been a good month for commodity-linked currencies in general, with NOK and CAD also making large gains and some analysts reckon they will continue to perform well, whether or not commodity prices jump higher.

For the Aussie Dollar, iron ore prices have been rising, up 32% since the mid-June lows.

The Pound to Australian Dollar exchange rate (GBP/AUD) has fallen from highs at 1.76 in mid-May to around 1.6347 while the Australian to US Dollar exchange rate has risen from 0.7350 in mid-May to record a level just shy of 0.80 this week.

But the gains have come too fast, too soon we are told and AUD is likely to end the year lower than current levels.

“We are looking stretched on our fair value model,” notes Martina Song at Westpac Bank in Sydney with regards to the Aussie’s valuations.

Song notes the commodity rally has certainly been a factor in the rise in fair-value recently, but the market are now above the top end of Westpac’s fair-value range and one standard deviation above (0.7950).

“AUD/USD is at highs since May 2015 and the TWI since Dec 2014. These are levels which we think are going to start making the RBA more uncomfortable,” warns Song.

Watch Reserve Bank of Australia (RBA) speeches over the next week as being potential opportunities for officials to talk the AUD lower or dampen rate hike expectations.

"We think the RBA may become more uncomfortable with current levels," says Ned Rumpeltin, European Head of FX Strategy at TD Securities.

Westpac meanwhile say they would require a further significant appreciation in commodity prices for them to be happy that an aggressive push into the mid 0.80s is possible.

Analysts at the Australian bank are sticking with their core view that the Australian Dollar is destined for lower levels later in the year. “For us, that means 0.75 not 0.85 before year end,” says Robert Rennie at Westpac in Sydney.

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However, Rumpeltin at TD Securities is more bullish on the Aussie saying the path of least resistance going forward is higher.

But for any significant rally Australian wages must pick up.

"The critical swing factor will be the labor market – wage growth in particular. We think wages have bottomed but it may be not enough evidence to convince the RBA to pull the trigger this year," says Rumpeltin.