Recent events and Australian dollar since May’s interest rate cut

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Australian Economy, Uncategorized

 

 

Last week’s Brexit referendum has led the Australian dollar spin in different directions which otherwise did not get any support from the strong gains in risk assets across European and US markets. This has raised a lot of speculations around RBA’s next move which brings market anticipation around rate cut to 1.5 per cent and lower.

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Australian Dollar/US FX Spot Rate (Source: Thomson Reuters)

The Australian dollar is moving high against the US dollar at the back of foreign money being drawn into Australian government bonds and other assets given factors such as lower triple-A rated sovereign credits coupled with Australia’s interest rates and US interest rate scenario. Even with the current volatility caused by Brexit, the AUD is showing signs of resilience in support from Australia’s high interest rates and triple-A rating by the three main credit rating agencies. The position has been further strengthened owing to the two-notch downgrade of the UK’s AAA sovereign debt rating by Standard & Poor’s while Moody’s brought the one-notch cut. Currency strategists are even pointing towards the fact that no other country like Australia has low political risks, positive yield and a AAA credit rating at the current scenario. This in turn can create pressure on economy and will again misbalance the transition from mining investment-led growth to growth originating from diverse economic activities. As a result, the Reserve Bank of Australia may bring upon further rate cuts. Various figures have been reported so far in terms of the rate cut forecast with Royal Bank of Canada changing its forecast to 1.25 per cent by mid-2017 from 1.5 per cent while Barclays changed its short-term call from 1.75 per cent to 1.5 per cent. Some analysts see cash rate as low as 0.75 per cent next year keeping in mind the August reduction holding a good probability. However, the move by the RBA is also dependent on the inflation data to be released in July. Given the AUD value, the Reserve Bank is thus anticipated to bring cash rate cut in the month of August at the face of low inflation and post-Brexit risks.

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Going back in time, the Reserve Bank of Australia cut the official interest rate to 1.75% in May 2016, which was a new historic low and three of the big four banks immediately followed suit by announcing that they would pass on the cut of 25 basis points. In response to the cut, the Australian dollar immediately fell by 1% to below 76 cents against the US dollar. This step was taken with an intention to stimulate inflation while also tapping the strengthening Australian dollar. Mainly, the rising Australian dollar had added to problems by making Australian goods and services increasingly more expensive in global markets. This is a head wind for an economy trying to increase the size of the service and manufacturing segments in relation to the size of mining and reducing the overdependence on Chinese demand for commodities such as iron ore, copper and coal. The RBA was seen in the exchange rate appreciation as a complication in making economic adjustments though its success in managing a lower exchange rate remains in question because central banks notably in Japan and Europe have consistently failed to weaken their currencies through the mechanism of cuts in interest rates. However, they have plenty of room to cut interest rates further, but will find it difficult to sustain the weakness of the Australian dollar in an environment which is soft on the US dollar. The momentum which lifted the Australian dollar more than US 78 cents has run out of steam and the Australian dollar is more vulnerable to a strong US dollar, especially in the face of expectations about US interest rates. A rally that began in the early weeks of March catalysed by robust GDP figures and other positive data had lifted the Australian dollar from below US 72 cents to more than US 78 cents that have been surrendered in the face of improving US data, including retail sales. As per May’s figures, the Australian dollar has since fallen more than 7% against the high in April, but further dramatic large falls in the Australian dollar against the US dollar were said to be unlikely, given the strong fundamentals. The Australian economy otherwise was reported to be in good shape with global commodity prices recovering and the current account deficit in Australia reducing.

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Cash Rate (Source: Reserve Bank of Australia)

Improved appetite for risk and the EU referendum has seen the Australian dollar trend against the GBP in a limited range and this is unlikely to change in the short run. Confidence in the Australian dollar has strengthened sharply in response to the Westpac Leading Index Report, which was better than expected. Overall the picture depicted that the economic conditions in Australia strengthened in May pulling investors back into the Australian dollar, particularly because the GBP was seemingly getting affected by Brexit. The publication of the RBA meeting minutes of June also somewhat supported the demand for the Australian dollar because of a neutral policy stance. The minutes of the June meeting of the RBA suggested that the approach to delivering inflation outcomes in accord with the targets will be measured.

However, today we seem to be in a bit different position and AUD is struggling to hold the ground. AUD rebounded (currently 0.74) against the greenback on June 27, 2016 after the initial post-Brexit fall to 0.738 last week.

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