Pound-Australian Dollar Rally Offers GBP a Shot at Top Spot for 2021 

 - GBP within arm's reach of No.1 spot in major FX for 2021.
- GBP/AUD sets out path to throne with 0.20% rise needed.
- GBP/AUD eyeing 1.81in  short-term but gains may not last.
- GBP a pressure release valve for central bank FX concerns.

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  • GBP/AUD spot rate at time of publication: 1.7709
  • Bank transfer rate (indicative guide): 1.7250-1.7360
  • FX specialist providers (indicative guide): 1.7440-1.7580
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The Pound-Australian Dollar rate advanced to a one-month high on Wednesday as fundamental tailwinds enabled Sterling to continue outperforming, although gains over its antipodean counterpart have brought the British currency within arm's reach of the top spot among majors for 2021. 

Pound Sterling led the board again on Wednesday having notched up increases over all of its nine largest rivals, with price action coming amid a rebound in risk assets like stocks and commodities but also after Office for National Statistics data showed inflation surprising on the upside for the month of the December. 

Core inflation rose from 1.1% to 1.4% in Britain last month, which is a bit of a double-edged sword for the Pound in a market that is said to be sensitive to changes in 'real yield,' given that rising inflation can reduce real yields if it leads investors' expectations of future price pressures to also rise. 

Rising inflation expectations would, when combined with a Bank of England (BoE) outlook that envisages no change in interest rates for years, reduce the inflation-adjusted 'fair value' of the Pound. However, the British currency appeared heartened by the data this Wednesday.

"GBP/USD continues to trend higher," says Kim Mundy, a strategist at Commonwealth Bank of Australia. "AUD is in a consolidation phase after jumping more than 10% from the start of November to early January.  While we consider AUD has some more upside based on high commodity prices, the recent (but temporary) lift in the USD is a headwind to AUD’s gains in the short term.  An emerging risk to AUD is reports the Chinese authorities want steel makers to cut production to reduce emissions of carbon dioxide.  Overall, we are comfortable with our forecast AUD ends Q1 2021 at 0.75." 

Above: Pound-to-Australian Dollar exchange rate faces Fibonacci resistance at 1.8272 and 200-day moving-average (pink).

CBA has warned of further upside risks to Pound Sterling exchange rates owing to a relentless climb by GBP/USD, which is tipped to hit 1.40 in the months ahead. This implies further gains are in store for the Pound-to-Australian Dollar rate, especially in any market where AUD/USD remains stalled at 0.77. 

The Pound-to-Aussie rate would rise to 1.81 if GBP/USD hits 1.40 while AUD/USD remained stalled at 0.77 and would rise as far as 1.86 if, as GBP/USD climbed, the AUD/USD rate fell toward the 0.75 forecast of CBA. 

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This would almost certainly be enough to lift Pound Sterling into the top spot among major currencies for the year thus far given that at 1.7720, GBP/AUD was down only -0.19% for 2021 on Wednesday while posing as the sole major British exchange rate not to have risen this year.

Sterling has been boosted by the BoE's step back from the brink of a negative rate policy and an almost best-in-class vaccination campaign, but GBP/AUD's gains have built only after AUD/USD strength wained. The Pound's time in the sun could also yet be limited by a resurgent Aussie too.

Above: GBP rates & performances Vs majors on select timeframes. Source: Netdania Markets. Click for closer inspection.

"Investors have rewarded currencies that are in the frontline of the vaccine rollout and similarly punished those seen to be slow in vaccinating. Here the EUR’s trade-weighted index slide is telling," says Ray Attrill, head of FX strategy at NAB. "It will take a challenge to the view that vaccine roll-outs in major economies will succeed in allowing for fuller economic re-opening and much stronger growth come H2 2021, to prompt a decline in commodity prices of sufficient magnitude to hurt the AUD. Such a scenario would doubtless also negatively impact risk sentiment to be a double whammy for the AUD. But is not our baseline assumption. As things stand, AUD/USD continues to perform almost exactly as it should in relation to key fundamental drivers. We continue to expect it to hit 0.80 before H1 2021 is out."

AUD/USD remains undervalued according to NAB and CBA, even after a 50% rally from March 2020 lows and thanks mainly to resurgent commodity prices that have lifted estimates of the Aussie's fundamental value.

This is a potential headwind for GBP/AUD upside because at the 0.80 level of AUD/USD, the Pound would be found trading back down at 1.75 against the Aussie even if GBP/USD succeeds in reaching 1.40 this quarter.

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NAB has said there's scope for GBP/USD to reach 1.42 but doesn't anticipate this happening until later in 2021, which is important because the Pound-to-Australian Dollar exchange rate always closely reflects relative price action in GBP/USD and AUD/USD. 

The Pound-Aussie rate would be found oscillating around 1.7750 in a market where GBP/USD is at 1.42 and AUD/USD at 0.80. This too would see Sterling made 2021's top performer among major currencies, a position that may be justified by proliferating central bank concerns about currency strength.  

The U.S. Dollar sell-off of 2020 is widely expected to continue this year but the problem is that other currencies' existing gains over the greenback have already lifted some countries' trade-weighted exchange rates to near what are problematic levels for central banks.  

Above: AUD/USD shown at weekly intervals alongside GBP/USD (blue).

"GBP’s nominal TWI is once again eyeing the range highs seen in the 4.5 years since the EU Referendum," NAB's Attrill observes. "We’ve long argued that once our base case of a trade deal was struck, GBP should start to reclaim some – but not all - of the weakness and arguably oversold ground that kept it low and cheap since 2016. That in turn likely means GBP’s TWI will break above the aforementioned range highs." 

Trade-weighted concerns are their most acute in Europe, where out of fear for its long elusive inflation target, the European Central Bank (ECB) is expected to remind the market that it's watching the EUR/USD rate closely when it announces its lates monetary policy decision this Thursday.

That exchange rate accounts for around a fifth of the Eurozone economy's trade-weighted currency, which would rise with EUR/USD and in the process reduce the cost of goods imported into the Eurozone and further stymie already and long-inadequate inflation pressures. 

EUR/USD gains back to recent highs would risk becoming self-defeating without a further rally in either Sterling or the Chinese Yuan because these are the only two currencies with a large enough weighting in the Eurozone's trade-weighted exchange rate for them to be able to offset EUR/USD moves.

 

Above: NAB graphs showing Sterling's trade-weighted exchange rate (left) and Euro's trade-weighted exchange rate.

The consensus EUR/USD rally and U.S. Dollar decline could therefore be contingent on continued outperformance by Sterling

Sterling has spent years below long-term averages against the U.S. Dollar and Euro as a result of the recently concluded Brexit process, while other currencies are at the opposite end of the field having risen sharply last year already. 

As a result, the Pound could be positioned to act as a pressure release valve for other currencies and their central banks, more so in light of uncertainty over if the incoming administration of President Joe Biden will really and truly lead to a positive reset of relations between the U.S. and China.

Such uncertainty could rule out a further rally in the Chinese Yuan over the short-term and leave EUR/USD even more dependent on Sterling.

"There will be little tolerance for countries that intervene to stop their currencies from rising," notes Michael Every, a global strategist at Rabobank. "Notably, Yellen also attacked China for intellectual property theft, trade barriers, “abusive” product dumping, and “illegal” SOE subsidies, which the US would continue to take on via “the full array of tools” – not a stance one would previously have associated with her."