Australian Dollar Forecasts at Soc Gen Show Potential 10% Rise Against Dollar & 5% Rise Against Pound

- Australian Dollar edges lower as USD trades on front foot Wednesday.

- AUD to rise 8.8% against USD, 3.9% against GBP show forecasts from Soc Gen.

- 7.5% upside against USD, 5.4% against GBP say CIBC Capital Markets.

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Latest forecasts from the Paris-based global banking giant Société Générale suggest the Australian Dollar has the potential to rise by almost 10% against the Dollar and Pound before the year is out as the Reserve Bank of Australia shifts its tone regarding future interest rate levels in Australia. 

Australia's Dollar has now fallen by 5.4% against the US Dollar in 2018 and is down by 3.5% against Pound Sterling after markets all but gave up any hope of seeing the RBA join its developed world counterparts in raising interest rates. 

That saw bond yields in the US overtake those in Australia while the gap between yields in the UK and Australia have narrowed, undermining a traditional source of support for the Australian currency. 

This matters for the Australian Dollar as global capital tends to flow to those jurisdictions with higher or rising interest rates because they offer a greater return for investors, in turn pushing up the value of the currency. The Australian Dollar has long benefited from the country's high rates relative to the rest of the world but now that other central banks are tightening policy and Australia is not budging, the Aussie unit's advantage has faded.

But, the tone and narrative towards Australian interest rates could soon start shifting in a direction that proves supportive of the currency once more.

"Inflation, both headline and core, are just under the RBA’s 2-3% target band. The growth tailwind should nudge inflation gradually higher, and we expect the RBA to switch to a tightening bias before year-end. The market has underpriced the probability of RBA tightening, in our view, and so there is likely to be a boost to the Aussie dollar in coming months as the market pricing firms up," says Alvin Tan, a currency strategist at Société Générale.

Above: The AUD/USD rate has endured a poor 2018 to date.

Key to the Reserve Bank of Australia's "on hold" stance is the outlook for Australian inflation.

With consumer prices stuck stubbornly below the lower bound of the central bank's 2% to 3% inflation target, there has been little need for it to begin raising the cash rate from its current record low of 1.5%. However, the Société Générale FX team say this downbeat inflation picture should improve later in the year, prompting markets to reappraise their expectations for RBA policy.

At the time of writing, the market-implied Australian cash rate for December 04 was just 1.5%, suggesting investors and traders currently see almost no chance of an RBA rate hike before year-end. Any change in this implied rate, and the associated probability of an increase in the policy rate, could provide the Aussie Dollar a powerful pickup.

However, investors will ultimately now be more interested in how the implied cash rate for 2019 starts to move.

"Australia continues to run a two-track economy. The economic outlook remains positive with robust employment growth and strong business sentiment. The drag on growth from the mining investment downturn is now mostly behind us. However, wage growth has been sluggish, and this has dragged on consumer spending. Household spending is also likely to take a hit from faltering house prices across Australia’s major urban centres," says Tan.

Australia's economy grew by 1% during the first-quarter, up from 0.5% in the final three months of 2017 and ahead of the upwardly-revised consensus for a reading of 0.9%, although the annualised growth rate of 3.1% was in line with the RBA's latest set of forecasts so the data did little to shift market expectations for interest rates. However, steady growth in China and a renewed pickup in the global economy are expected to further support the trade-sensitive Aussie economy this year.

"The ongoing Chinese structural slowdown is expected to stay modest, which should provide support to Australia’s commodity exports. Through the rest of the year, our commodity strategists see iron ore prices above $60/t and crude oil prices around current levels (relevant for LNG prices). The Australian terms-of-trade upswing since 2016 should provide fundamental support to the Aussie dollar," Tan writes, in a recent briefing. 

Above: Pound-to-Aussie rate shown at daily intervals.

Tan and the Soc Gen team are not alone in having an optimistic view of the Australian economy or currency for 2018. Strategists at CIBC Capital Markets also reiterated a bullish view on both just this week, saying the Aussie economy has "outperformed" this year and that markets are too pessimistic on the RBA outlook. 

"With the market already discounting significant bad news (net positioning remains negative) it wouldn’t take much of an uptick in the data backdrop, or commodity influences, to encourage a positioning reversal and modest gains in AUD valuations. Overall, we still see AUD gaining against the greenback in the months ahead," writes Patrick Bennet, a macro strategist at CIBC Capital Markets, in the bank's monthly FX outlook. 

Forecasts for the Australian Dollar

Bennet and the CIBC team are looking for the Aussie Dollar to rise to 0.79 against the US Dollar before year-end, implying upside of 7.5% from Wendesday's levels, and for the Pound-to-Aussie rate to drop 5.6% to 1.68.

The Société Générale are even more bullish in their forecasts for the currency. Tan projects the AUD/USD rate will rise to 0.80 before year-end, an increase of 8.8%, although they predict only a 3.9% fall to 1.71 for the Pound-to-Australian Dollar exchange rate.

The AUD/USD rate was quoted 0.02% lower at 0.7387 Wednesday while the Pound-to-Aussie rate was down 0.10% at 1.7806.

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