Australian dollar has gained by over 6.5% over the pound in the past two months, strengthened by nearly 7.5% against the USD in the past six weeks, and hit fresh record highs against the euro only this afternoon. The Reserve Bank of Australia cut its interest rate to 3.50% in early June and its key trading partner China continues to slowdown, so what is driving this latest rally in the aussie dollar?
One major factor fuelling the current positivity towards the AUD is the development that the German central bank, the Bundesbank, is set expand its portfolio of Australian assets. The eurozone crisis has caused central banks all over the world to review their reserve allocations and among others who are set to invest in Australian assets is the Czech central bank. This factor has completely overshadowed any dampening effects you might have expected as a result of the collapse of risk appetite that saw many higher-yielding currencies and equities decline since early May.
In addition, Australian economic data has in general held up remarkably well given the decline being seen in the Chinese economy (Chinese GDP has slowed down from a pace of 9.5% to 7.6% in the past year). Recent data revealed that Australian GDP expanded by an impressive 1.3% in Q1 of this year, well up from Q4 2011’s figure of 0.6%. This domestic economic strength gave the Reserve Bank of Australia the confidence not to cut its interest rate again in July.
However, we are seeing considerable risks of a rate cut in August as this domestic performance looks unlikely to persist. Recent Australian data has taken a downturn, particularly in terms of the domestic labour market. As well as July’s weak labour numbers, forward-looking indicators point to further softness.
Importantly, data revealed a sharp drop in Chinese imports from Australia in June and weekly New South Wales coal shipments have also fallen off this month. Equally, Chinese steel production has declined and its iron ore inventories have climbed, suggesting waning demand for aussie exports in the months ahead. As well as further deterioration in Chinese growth, we take a gloomy view as to the outlook for global growth and financial conditions, driven not least by eurozone risks. If a rate cut doesn’t come in August, we would be very surprised if it didn’t come in September.
For these domestic and international reasons, we see the AUD rally halting soon. AUD/USD should fail to sustain any breach of 1.05 and we should see this rate head back down toward and below parity in the coming months. In terms of GBP/AUD, downside scope is looking increasingly limited. The aussie is deep in overbought territory and we expect 1.55 will be seen once again before long. In addition, when the aussie dollar does endure its downward correction, it could well be quite a brutal move.
Richard Driver
Analyst – Caxton FX
For the latest forex news and views, follow us on twitter @caxtonfx and sign up to our daily report.
