Forecast: Australian Dollar Upside Ahead say Westpac, Commerzbank

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- AUD bounces higher alongside China's Shanghai Composite index. 

- Charts suggest scope for AUD to recover further says Commerzbank

- While Westpac says it's time to walk away from bets against the AUD.

The Australian Dollar rose into the mid-week session as it tracked the Chinese stock market in its recovery off multi-year lows, and analysts at both Westpac and Commerzbank are suggesting it could move higher still. 

China's stock markets have suffered severe losses in 2018 but they've rebounded in recent days as markets respond to pledges from the Ministry of Finance to cut taxes this year and next in order to support the economy in the face of President Donald Trump's trade war against the country.

Efforts by authorities to prevent a pickup in capital outflows from China may also have propped up stocks in Shanghai and supported the Renmimbi. A UBS Group private banker was recently detained, with markets taking its as a sign of authorities attempting to prevent money leaving China.

"AUD outperformed most major currencies during the Asia session supported in part by higher Chinese equity markets. The CSI300 index is up about 1.75%. But Chinese policymakers will likely need to implement more reflationary policies to shore-up financial market conditions on a sustained basis," says Elias Haddad, a currency strategist at Commonwealth Bank of Australia. 

Chinese stimulus measures are important for the Aussie because the Antipodean currency is underwritten by Australia's mammoth commodity trade with the world's second largest economy. This means whenever the Chinese economy or currency receives a boost, so too does the Australian Dollar.

That relationship explains, in part at least, why the Aussie has lost around 9% of its value relative to the U.S. Dollar this year, amid President Donald Trump's "trade war" against China.

Trump has imposed tariffs on more than $250 billion of China's exports to the U.S. back in July. He is now threatening to target the full $500 billion or more of goods that China sells to the U.S. each year if the country does not abandon its "unfair trading practices".

The AUD/USD rate was quoted 0.15% higher at 0.7101 Wednesday but is down 9% for 2018, while the Pound-to-Australian-Dollar rate was 0.14% lower at 1.8276.

The GBP/AUD exchange rate was quoted 0.21% lower at 1.8264, well off the current month's highs at 1.8366.

And, analysts at Commerzbank believe the recent improvement in the Aussie's performance could extend a little further.

"Intraday Elliott wave counts have neutralised. We look for gains to remain capped by the 55 day moving average at 0.7202 and the 0.7280 2018 channel and while capped here this will leave the market under overall pressure," says Karen Jones, head of technical analysis at Commerzbank in London.

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AUD Improvements in China

The Shanghai Composite index was 1.54% higher at 2,629 at the time of writing, but is still down by nearly 21% for 2018.

"China has rolled out a series of speakers and rule changes to stabilize markets. Sure, it’s easy to be cynical about the long-term impact of this sort of stuff but in the short run it pretty much always works. And the market has been selling Asia for months so there is plenty of room for some mean reversion," says Brent Donnelly, a spot currency trader at HSBC, in a note to clients Monday.

The U.S. tariffs have driven a slowdown in the Chinese economy and stoked fears for Australian economic growth too.

Those fears, and a deterioration of the domestic inflation picture, have led to a darkening of the Australian interest rate outlook and some steep losses for the Antipodean currency this year. But things could now be changing on that front. 

Westpac, one of Australia's largest lenders, has a programmatic model that produces currency trading recommendations. It has achieved an annualised return of 4.7% each year and this week, began suggesting to the Westpac team that they should cash up and walk away from bets against the Australian Dollar. 

"The model finally quits its AUD short position, a strengthening growth signal in the wake of last week’s sharp fall in the unemployment rate from 5.3% to 5.0% the main catalyst," says Richard Franulovich, head of FX strategy at Westpac.

Much like Commerzbank implies, Franulovich and the Westpac team say the AUD/USD rate could recover toward the 0.72 level over coming weeks, now that the market appears to have bottomed. 

The model's signal comes in the wake of September's labour market report which showed a sudden and surprise fall, from 5.3 to 5%, in the unemployment rate last month.

This has nurtured a burgeoning sense of hope among some analysts that Aussie wage growth could soon begin to pick up, which would be positive for the inflation, economic growth and interest rate outlook.

The Reserve Bank of Australia has held its interest rate at a record low of 1.5% for what is now the 27th consecutive month, while the U.S. Federal Reserve and Bank of Canada have raised their own rates to 2.25% and 1.5% respectively.

The U.S rate is expected to finish 2018 at 2.5% while analysts say the Canadian benchmark will rise to 1.75%.

This has turned the tables on the Australian Dollar, which has for the last two decades benefited from interest rates that were typically higher than those elsewhere in the developed world.

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Bank-beating GBP/AUD exchange rates: Get up to 5% more foreign exchange by using a specialist provider to get closer to the real market rate and avoid the gaping spreads charged by your bank when providing currency. Learn more here