Pound to Gain 10% vs. Australian Dollar Show ANZ Forecasts

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The Pound is tipped to extend its multi-month trend higher against the Australian Dollar through 2018.

The Pound could see a double digit rise against the Australian Dollar before the end of December, according to the latest forecasts from Australia and New Zealand Banking Group (ANZ), who say the Bank of England will afford Sterling a boost while the Aussie falls victim to a less favourable offshore environment.

Australia's third-largest bank says the Australian Dollar, meanwhile, will find little support from its own central bank and should extend a longer-term period of decline against the Pound. A move that has been in place since since early 2017.

The call comes when the Pound-to-Australian Dollar exchange rate is quoted at 1.7682, having been as low as 1.7098 earlier in 2018 while the 2017 low was 1.5905:

Britain’s currency will remain subject to bouts of volatility owing to Brexit negotiations, but the Bank of England’s increasingly intolerant attitude toward UK inflation should provide some grounds for cheer during the months ahead.

“Sterling’s medium- to longer-run prospects remain clouded by uncertainty surrounding the Brexit negotiations. But short-term sentiment is more receptive to the political manoeuvrings of the opposition Labour Party, the slightly hawkish overtures from the BoE and a reasonable growth outlook,” says Brian Martin, an FX strategist at ANZ Bank.

The BoE warned in February that it could raise interest rates faster than previously expected if the inflation outlook evolves in line with its latest forecasts. Rising interest rates will support the Pound by drawing international capital away from markets where rates are either flat or falling.

The opposition Labour Party has begun to pressure Prime Minister Theresa May over the EU customs union, which is the EU framework governing tariffs levied on imports from outside the EU, leading markets to price in the potential for a softer Brexit which is typically seen to be an outcome favourable to Sterling.

Labour is pushing for a replica of the current customs union after Brexit, but the government says such an outcome would  hamper the UK’s post-Brexit international trade objectives and be a betrayal of the referendum result as it would not deliver independence from the EU.

“Whilst politics and the future relationship with the EU are major uncertainties, an EU transition period until end-2021 is expected to be agreed soon. That would reduce immediate economic risks, whilst opposition support for a soft Brexit may temper the government’s approach to negotiations,” Martin adds.

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A Tough 2018 for the Aussie

Meanwhile, in Australia, domestic economic conditions are yet to evolve sufficiently to prompt the Reserve Bank of Australia into raising interest rates any time soon. The RBA appears to also be concerned with regards to developments in global financial markets; something the economy and Aussie Dollar are sensitive to. 

“The past month has cemented the fact that the AUD will not be driven by domestic factors. While the economy is in solid shape, it is not going to shift the RBA,” says Daniel Been, head of FX strategy at ANZ Research.

“The Governor clearly highlighted that the Bank believes plenty of spare capacity is still available in the economy and signalled it would wait patiently for a move to the centre of the band for inflation. So, a rates move is off the table, for now.”

So while the UK is seen raising rates over the coming months, Australia is not, which could create a supportive interest rate environment for Sterling.

The RBA has held its cash rate at a record low of 1.5% for 19 months in a row while, according to pricing in interest rate derivatives markets, investors do not currently expect Australian rates to rise until at least February 2019.

“In a year where growth peaks and policy tightening will start to bite, we have a strong conviction that volatility will rise and that deteriorating risk appetite will weigh consistently on the AUD,” says Been, referring to the offshore environment.

Global economic growth picked up in 2017, leading to wave of upgrades by the International Monetary Fund and mounting expectations that global interest rates would soon need to rise, which would contain inflation but also crimp the economic expansion.

Higher interest rates and the threat of a potential slowdown in growth could be enough to burst the bubble in global stock markets, which already showed signs of stress in early February, leading to an increase in risk aversion among investors.

“The recent rise in US rates, and the resultant return of volatility has exposed a vulnerability. The pace with which liquidity fell surprised us, even though we were expecting it to decline,” says Bean.

“This will mean that volatility remains more elevated on average and, as such, has prompted us to revise our forecasts. We now think that the peak in the AUD is behind us.”

It's not only ANZ who are bearish on AUD in 2018. This morning analysts at Wall Street investment bank Morgan Stanley have reiterated their call that 2018 will not be kind for AUD.

"We continue to view the Australian economy as structurally weak with stretched consumers, a weakening housing market and tighter credit conditions stemming from macroprudential measures. These weaknesses should gradually be transmitted to the AUD, which we project to decline meaningfully through 2018."

Interest Rate Divergence to Weigh on AUD

The Australian Dollar will have to contend increasingly with an emerging gulf between its own domestic interest rate and that of the United States in 2018 and beyond.

Interest rates are already at 1.25% in the US and are expected to rise between three and four times in 2018, leaving the top end of the Federal Funds rate range somewhere between 2% and 2.25%.

This is expected to keep pushing US bond yields higher, while yields available on Australian government bonds are deprived of an offsetting lift that expectations are for the RBA’s cash rate to remain static.

“This means that the AU/US rate spread is likely to stay where it is – a few basis points in the US’s favour. And when you look at what this means for the AUD in isolation, a model indicates that fair value rests somewhere in the USD0.60s,” says Been, although he notes this “fair value” number is unlikely to materialise in market pricing. At the time of writing AUD/USD was at 0.7795

These interest rate dynamics could pressure the Australian Dollar against the US Dollar, with adverse implications for the Aussie currency across the board, given that most other currencies have been and are still rising against the US currency.

“Until we see some evidence of wages growth, the RBA will remain on the sideline, and the AUD will continue to be dictated to by global forces,” Been adds.

Above: AUD/USD rate shown at weekly intervals.

ANZ Forecasts: 10% Upside for Pound-to-Aussie

Been and the ANZ team adjusted their exchange rate forecasts Wednesday, marking down the Australian Dollar by a few cents while upgrading the Pound in response to a brighter UK interest rate environment and hopes of a more benign Brexit outcome.

ANZ forecast the AUD/USD rate will now fall to 0.72 in time for year end, down from their previous forecast of 0.74. They also downgraded their forecasts for the exchange rate in March, from 0.80 to 0.77, and in June, from 0.82 to 0.76.

For Sterling, the bank predicts a Pound-to-Dollar exchange rate of 1.40 at the end of March and 1.42 at the end of December. These are up from their forecasts of 1.35 and 1.37 issued in November 2017.

For the Pound-to-Aussie rate, this means an exchange rate of 1.9722 by year end, which is up from the 1.8513 forecast of November 2017 and around 10% above Wednesday’s market price of 1.7708.

Pound-to-Aussie is, after all, a foreign exchange cross rate that is calculated at its most basic level by dividing the Pound-Dollar rate over the Aussie-Dollar rate.

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