GBP/AUD: With A Perfect Storm Gathering Overhead This Pair Could Go Higher

Market doubts over the Reserve Bank of Australia's position could push the Pound-to-Australian-Dollar rate higher still.

The Pound could extend its gains over the Australian Dollar during the coming months if the Bank of England remains on a hawkish footing and doubts over the Reserve Bank of Australia's position set in, according to strategists at Morgan Stanley.

"The BoE looks increasingly likely (based on market pricing) to hike rates in the "coming months" which should temporarily boost GBP, but multiple hikes seem less probable as the MPC balances the high inflation with weak growth," says James Lord, a strategist at Morgan Stanley.

Sterling gained more than 1% against its Antipodean rival Friday after one of the Bank of England's most vocal advocates of a lower-for-longer interest rate policy came out and said a rate hike will be imminent if inflation further overshoots its 2% target during the months ahead.

"We are approaching the moment when bank rate may need to rise...the appropriate time for a rise in bank rate might be as early as in the coming months," Gertjan Vlieghe, a Monetary Policy Committee member, said in prepared remarks at a conference Friday.

RBA: Stick or Twist?

This is while the Australian economy, after recently having seen an upturn that has so-far supported the Aussie Dollar, may not gain enough momentum to warrant a move by the RBA in 2018.

“Markets have been questioning whether the Reserve Bank of Australia could follow the Bank of Canada and move towards hiking rates. Our analysis and our economists' expectation is that it is unlikely to happen any time soon,” says Lord.

The RBA left the cash rate unchanged at 1.50% for the 13th month in a row earlier in September and also sounded a brighter tone on the economy.

Governor Lowe and fellow policy makers noted an improvement in the non-mining investment outlook, a steady labour market and a housing market that has now become to cool in some parts after years of runaway price growth - which reduces financial stability risks. 

"The market is currently pricing 63bp of hikes in Canada and 36bp of hikes in Australia by the end of 2018. The Australian rate pricing seems fair from a market perspective but could shift lower next year if inflation-related data weaken," says Lord.

The Inflation Trade:

The Pound-to-Australin-Dollar exchange rate has now risen by 3.48% in the last week alone, with the nascent rally beginning last Tuesday in the wake of August's inflation data.

August inflation came in 30 basis points higher than the previous month's number, rising to 2.9%, and now threatens the key 3% level.

If the consumer price index touches 3% then the Bank of England governor will have to right a public letter to HM Treasury outlining a plan to return inflation toward target, which could mean even more talk of rate hikes to come - or even an actual hike itself.

Meanwhile, in Australia, policy makers are more worried about inflation being too low, while some strategists have said any rate hike would be contingent on an eventual depreciation of the Australian currency, given its potential to curb inflation.

“The elevated AUD will keep imported inflation contained in the near term,” says Sean Callow, foreign exchange strategist at Westpac.

Much of the inflation seen in the UK has been the result of exchange rate depreciation, brought about by the June 2016 Brexit referendum, and has flagged the culprit behind a 2017 slowdown in consumer spending and economic growth.

"Over the coming weeks, market pricing for a Nov hike is likely to increase, which should take GBP higher... For GBP to weaken, consumer-related data would need to undershoot expectations significantly or PM May's leadership called into question. In this context, the upcoming retail sales print will be important," says Morgan Stanley's Lord.