Australian Dollar to See Fresh Losses in Second-half of 2019 as RBA Starts Cutting, says Westpac

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- RBA minutes make for dovish reading, offer nothing to AUD. 

- Weak growth amid strong employment gains perplexes RBA.

- Eyeing weak economy, Westpac forecasts two 2019 rate cuts.

The Pound was trading higher versus the Australian Dollar on Tuesday after the Reserve Bank of Australia (RBA) released the minutes from its March meeting that made dovish reading for investors, although the exchange rate could rise further still if Westpac is right with its latest interest rate forecasts.

Tuesday's RBA minutes reflected what has been perceived as a cautious stance among policymakers, given an uncertain outlook for both the domestic and global economies, although the bank hasn't yet said that it is going to cut its interest rate. 

RBA rate setters were clearly perplexed in their latest meeting by the paradox of falling economic growth alongside a strengthening labour market. The RBA said in its March decision that it would cut its interest rate if the unemployment rate undergoes a "sustained increase" this year or next.

“Members noted the tension in a number of economies between slower GDP growth and resilient labour markets. Domestically, there continued to be tension between the ongoing improvement in labour market data and the apparent slowing in the momentum of output growth in the second half of 2018,” the minutes say.

The RBA has adopted what is ultimately a neutral, economic-data-dependent stance, which is not that much different to the newly-adopted position of the U.S. Federal Reserve (Fed).

This means labour market data covering the month of February is likely to be of special interest to the RBA board and to the market. The RBA says that risks are finely balanced between a possible rate cut and an interest rate hike being delivered in the coming months, but the market is much less optimistic.

Investors are currently betting on two interest rate cuts being delivered before the end of 2019. The market-implied cash rate for December 03, 2019 was just 1.12% on Tuesday, which is far below the current 1.5% cash rate and implies that markets are close to betting the house on two full rate cuts. 

Above: Market pricing of RBA cash rate. Source: Westpac

Westpac, one of Australia's four largest banks, is also now forecasting two interest rate cuts this year, with the first seen coming in August and the second in November. 

The bank cites waning economic growth, which fell from an annualised pace of 4.0% in the first half of 2018 to little more than 1.0% in the second half, as being behind its projections. The RBA is still forecasting a 3.0% GDP growth rate for 2019, but Westpac says the actual number will probably be close to 2.2%.

If Westpac's forecasts are right then the RBA is obviously wearing rose-tinted glasses, which it will soon have to take off.

"For Australia, iron ore and coal prices remain key. Over the past year, both markets have seen significant supply disruptions and a seeming unwillingness (or inability) of producers to quickly offset the production loss. Coupled with ongoing structural reform (which preferences high-quality inputs) and strengthening construction-related demand for steel in China, impaired supply has resulted in elevated price levels for both iron ore and metallurgical coal," says Elliot Clarke, an economist at Westpac. 

Westpac says the AUD/USD rate will meander between the 0.68 and 0.70 levels for much of this year, which is close to its current level, despite the dire interest rate outlook. This due to upward pressure on prices of some key exports which, technically, improves the fundamental value of the Aussie Dollar.

However, investors are increasingly being incentivised into selling their Australian Dollar bond holdings because of the combination of interest rate policies in Australia and elsewhere in the world.

That combination means investors can already earn a better return through buying bonds of the U.S. or other governments instead of the Australian one. And that incentive will grow larger still this year if Westpac's interest rate forecasts are correct.  

"While support from these yield-seeking flows will persist, given the global backdrop and Australia’s growth outlook, it seems inevitable that they will moderate hence. Ergo, the ability for the Australian dollar to maintain or exceed the USD0.70 figure is only likely to remain until mid-2019 after which the above growth; interest rate; and commodity dynamics will re-assert," says Clarke. 

Given the base case scenario is for a soft-Brexit and, therefore, further upside for the Pound, the impact of RBA rate cuts on the GBP/AUD rate could be a very positive one. Especially given expectations of a possible rate hike in the UK during August, which might come at the same time as the RBA is cutting rates.

The AUD/USD rate was quoted -0.07% lower at 0.7092 Tuesday while the Pound-to-Australian-Dollar rate was 0.15% higher at 1.8715.

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