Australian Dollar and Lockdowns: RBA Caution Over Lockdowns Could Trigger Weakness

- AUD softens, new lockdowns pose downside risks
- Lockdowns come just days before July RBA meet
- Goldman Sachs forecast softer AUD profile

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Foreign exchange analysts say the increased uncertainty caused by new lockdowns in Australia over recent days could trigger further Australian Dollar weakness, but only if the Reserve Bank of Australia becomes more cautious.

The Reserve Bank of Australia (RBA) - whose policy settings are a key driver of Australian Dollar value - could sound a more cautious tone at their July 06 policy meeting owing to new lockdown restrictions being imposed across the country.

The RBA will now be digesting news that Perth has now joined Sydney and Darwin in full lockdown, meaning that about 80% of the country’s population is subject to restrictions.

Meanwhile, internal border controls are tightening and this will negatively impact business activity in the country over coming days and weeks.

"If the uncertainty caused by the latest developments impacts RBA expectations, the AUD/USD could be exposed to renewed weakness," says John Noonan, a Reuters market analyst.

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Authorities in the country are increasingly concerned about this next phase of the pandemic; the spread of the Delta variant led Prime Minister Scott Morrison on Monday to call an urgent meeting of the country's national security committee.

Expectations for monetary authorities the RBA to strike a more-cautious-than-expected tone on July 06 owing to the developments will therefore likely rise.

The Australian Dollar is meanwhile beginning to show some nerves: the Pound-to-Australian Dollar exchange rate has risen to 1.8370 but is still some way off June highs towards 1.85.

The Australian-to-U.S. Dollar exchange rate is a third of a percent lower day-on-day at 0.7540, putting the 2021 low at 0.7477 in contention.

The Australian Dollar would likely be weaker were it not for supportive global developments that sees the currency tend to rise in tandem with stock markets and commodity prices.

The global picture ultimately remains supportive of the Australian currency given leading U.S. share indices hit record highs again overnight.

But RBA policy matters greatly too, with economists saying the low interest rates on offer in the country are not attracting the same volumes of foreign investor capital as has been the case in the past.

The lower rates means the Aussie Dollar has been unable to fully participate in the rally in global stocks and commodities.

Expectations for higher rates at the RBA have nevertheless risen over recent weeks owing to the strong external environment combined with a solid domestic economic recovery, thereby supporting the Australian Dollar somewhat.

"A growing number of analysts are predicting they will be forced to raise rates as early as Q4 2022," says Noonan.

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"Following a surprisingly hawkish FOMC meeting, focus has turned to the prospects for tighter policy across the G10s; and given Australia’s rapid economic recovery and an RBA meeting fast approaching, much of that focus has centered on future RBA policy," says Zach Pandl, an economist at Goldman Sachs.

A clear risk to this dynamic is that the RBA could turn more cautious on the outlook as they fear the economic recovery could be stifled by rising Coronavirus cases and associated restrictions.

"While the market has priced in a number of hikes by 2024, our economists still expect that the RBA will not initiate lift-off until May 2024," says Pandl.

At least 20 new Covid cases were reported across Sydney on Monday after the city of five million entered a two-week lockdown at 6pm on Saturday.

The rising cases come amidst a strikingly slow vaccination rollout which means the country will be forced to pursue aggressive lockdowns in order to maintain their zero-covid policy well into 2022.

Data from the Australian government shows only about 1.4 million double doses of vaccine have been administered in the country of 25 million people, with the BBC reporting pharmacies are sitting on stockpiles of unused AstraZeneca shots.

A risk to the economic outlook is that lockdowns are extended to contain the highly transmissible Delta variant of the virus, negatively impacting on business activity and consumer confidence.

The situation also means the country will likely clamp down further on international rivals, tightening what is effectively one of the strictest border policy in the world.

The shut border policy remains popular with Australians, however concerns are rising over the ongoing economic cost of the policy and the longer-term impact it will have on Australia's ability to compete globally.

Noonan says there was rising speculation the RBA might on July 06 drop the reference from previous statements that conditions for a rate rise are "unlikely to be until 2024 at the earliest."

"Such expectations may have to be scaled back due to the rise in coronavirus-related uncertainty, which the RBA has previously flagged as a continuing concern," says Noonan.

The RBA has previously flagged Covid as a continuing concern and the June meeting statement noted: "an important ongoing source of uncertainty is the possibility of significant outbreaks of the virus".

"The RBA may use the lockdowns as cover to push back against the market's more hawkish predictions. The bank's insistence that the economy needs more stimulus hasn't wavered and any tweak to their bond-buying programme announced at the July meeting is unlikely to be delivered with a hawkish tone," says Noonan.

Strategists at Goldman Sachs tell their clients in a weekly note the market should now price with more confidence that the RBA is unlikely to materially tighten policy before 2024, making it an outright laggard compared to peers.

Goldman Sachs exchange rate forecasts reflect this view through mild underperformance on AUD crosses, namely versus NZD, CAD, or EUR.

"Should market pricing move toward our forecasts, our estimates suggest that AUD is poised for slightly more underperformance relative to some of its G10 peers," says Pandl.