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Australian Dollar Shrugs at RBA Forecast Update but Recovery Still Has Further to Run says CBA

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- AUD eases lower as USD rebounds, market digests RBA forecasts.

- RBA upgrades growth, inflation and unemployment rate forecasts.

- Interest rate outlook improving, to further boost AUD says CBA.

The Australian Dollar took a breather Friday as markets digested fresh forecasts from the Reserve Bank of Australia (RBA), but analysts say the Antipodean currency's recovery still has further to run.

Reserve Bank of Australia policymakers formally upgraded their forecasts for GDP growth and unemployment Friday but revisions to its projections of core inflation were relatively small. 

Australia's economy is forecast to grow by 3.5% on average in 2018 and 2019, which is an upgrade from earlier projections suggesting growth would be 3% in both years. 2020 GDP is forecast at 3.5%, up from 3% previously.

This leads the unemployment rate down to 5% by the end of 2019 and 4.75% the next year. The RBA had forecast unemployment would fall to 5.25% and 5% respectively.  

"One additional level of support for AUD/USD is the bottoming out in the U.S.-Australia unemployment rate differential. It has been a helpful guide to major turning points in AUD/USD. It is likely that the U.S. unemployment rate won't fall much further, but Australia's will, generating some further support for AUD," says Adam Myers, a currency strategist at Commonwealth Bank of Australia. 

Faster growth and lower unemployment is expected to encourage higher levels of wage growth over coming years but the spillover into the consumer price index is only likely to be modest. 

RBA policymakers say the main rate of inflation will rise at exactly the same pace as previously projected, reaching 2.25% at the end of 2019, up from 1.9% currently. 

Underlying inflation, or true domestically generated inflation, is forecast to pick up a little faster. It now reaches 2.25% at the end of next year, up from the 2% projected back in the summer. 

Inflation has been below the 2% to 3% target for much of the time since 2014 and remains there more than two years after the RBA cut its interest rate to a record low of 1.5% to stimulate growth and stoke consumer price pressures.

"The recent string of good Australian economic data has meant the interest rate market pricing for a 2019 RBA rate rise has picked up. The prospect of higher market rate should provide AUD/USD with a good level of support and higher average level, assuming the favourable Australian economic data continues," says Myers. 

The AUD/USD rate was quoted 0.33% lower at 0.7242 Friday and is now down by just 7.2% for 2018. 

The Pound-to-Australian-Dollar rate was down 0.11% at 1.7964 Friday and has now risen just 4.2% this year.

"AUD/USD Looks to be executing a return to point of break out from the channel, which should now offer support at .7232. The close above the channel has negated downside pressure and is expected to trigger a move to the .7474 9th July high," says Karen Jones, head of technical analysis at Commerzbank.

The Reserve Bank has held its interest rate at a record low of 1.5% for more than two years now, citing below-target inflation and a litany of risks to the inflation and growth outlook.

RBA interest rate policy was a key instigator of the spectacular sell-off that drove the Australian Dollar almost 10% lower against its U.S. rival during the 10 months to the beginning of November.

Australian bond yields have fallen as the RBA made clear it intends to sit on its hands, while U.S. yields have risen due to a stellar performance from the economy that has enabled the Federal Reserve (Fed) to go on raising its benchmark rate.

This turned the gap, or spread, between the two bond yields against the Aussie and, in the process, created an incentive for investors to sell the AUD/USD rate. That explains a large part of the Aussie's steep 2018 loss. 

Optimism about the growth outlook comes after the Australian Dollar escaped its "bear trend" earlier this week. Multiple analysts have since said the Antipodean currency is on course for further gains. 

Friday's modest upgrades to the bank's inflation forecasts and an improving outlook for consumer price pressures could eventually see traders respond with a renewed bid for the Australian Dollar.  

"Dips lower will find initial support at the 55 day moving average at .7173 and the market will stay immediately bid above here," says Commerzbank's Jones.

 

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