Australian Dollar Forecast to Stay Soft as Bushfires seen Sucking the Confidence Out of Domestic Confidence

- Domestic pessimism holds Aussie Dollar back

- Bushfires to exact notable short-term economic toll

- RBA odds-on to cut interest rates in Feb

Aussie bushfires

Above: Bushfires across Australia are being tipped to exact a notable short-term economic impact on the country. Image © Adobe Images

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Weakness in the Australian Dollar is being forecast to remain a feature on global currency markets for some time yet, as a supportive global picture contrasts to growing domestic headwinds that have seen a rapid increase in bets that the Reserve Bank of Australia will cut interest rates to 0.50% in February.

The Australian Dollar has been subject to two opposing forces of late:

1) On the upside are a decided improvement in the global outlook courtesy of the Phase 1 trade deal reached between China and the U.S., as well as the settling of tensions in the Middle East and the growing consensus that the global economy is moving away from recessionary territory.

2) On the downside are the bushfires which are tipped to have a notable short-term negative economic impact, and fading sentiment on the domestic economy.

Subdued domestic confidence

Image courtesy of AMP Capital

Navigating the currency's outlook is therefore a question of balancing the two sides out, and at the current time the expectation is that the domestic negatives are holding sway.

"The size, intensity and duration of the current Australian bushfires mean that they will almost certainly have a larger economic impact than past fires," says David Plank, Head of Australian Economics at ANZ.

Recent statistics show more than 7 million hectares of bush has been burned, with more than 1800 homes destroyed. More than 25 people have reportedly died, in addition there have beens significant loss of livestock and some estimates show more than a billion wild animals might have been killed.

Aussie Dollar outlook

Above: While the La Nina and El Nino events are a cyclical driver of drought and abundance in Australia, the extreme temperature events recorded in Australia are trending higher and at more regular intervals:

Aus Dollar outlook

Image courtesy of AMP Capital

"The fires have been very widespread, have been going on for several months now and the crisis is continuing, so there will be a significant short-term negative impact and it likely will involve more than a short-term disruption to economic activity," says Dr Shane Oliver, Head of Investment Strategy and Economics and Chief Economist at AMP Capital in Sydney.

Signs that the fires are having an economic impact have already been flagged up in ANZ's job advertisements monitor. The monitor showed a 6.7% m/m drop in December, which took ANZ Job Ads down to its lowest level since April 2016. Typically this monitor has little interest for financial markets, but the sharp decline corresponding to the bushfires piqued interest.

ANZ Senior Economist, Catherine Birch said: "In the final two weeks of December, the number of job ads declined by more than we would expect for that time of the year, suggesting that the escalating bushfire crises had an impact."

ANZ say the current bushfires could see a short-term negative impact on employment, adding they expect the immediate impact on GDP over the final quarter of 2019 and the first quarter of 2020 will be negative, but most likely not beyond 0.1–0.2ppt per quarter.

AMP Capital's Oliver says a bigger impact on economic activity is likely to come via a hit to consumer spending as the constant news of the fires and the smoke haze in several capital cities weighs on confidence.

"There is enough in this for the RBA to conclude that the gentle turn in the economy is continuing. But we still think it more likely than not that the RBA will decide that the path of least regret is to ease again in February," says Plank.

However, a strong labour market report for December - out on January 23 - may change that calculation.

There has however been a notable shift in expectations for a February interest rate cut during the early part of 2020, and this shift has in turn heaped pressure on the Aussie Dollar. The market probability for a February rate cut has now risen up to 53.4% from a low of 36% before Christmas) and to 0.25% probably in March.

In sympathy with the shift in RBA expectations, the Australian Dollar last week fell a percent against the U.S. Dollar, 0.9% against the Pound and half a percent against the Euro. The Aussie has only managed to advance against the Yen and Swedish Krona in the G10 space.

Shifting expectations

"The likelihood of more RBA monetary easing and continuing weak economic growth in the short term will likely keep Australian bond yields down relative to global bond yields, possibly pushing them lower," says Oliver. "This will also keep the Australian dollar relatively soft."

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