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Australian Dollar Forecast Lowered at Westpac, but 2022 Recovery Expected

- AUD/USD forecasts lowered
- But AUD recovery expected in 2022
- NSW reports record Covid count

Australian Dollar outlook Westpac

File image © Westpac.

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The Australian Dollar might be the worst performing major currency of the past month, but steady gains are likely to be realised from the end of 2021 and through to 2023.

This is according to Australian lender and investment bank Westpac who have released new research detailing lower forecasts, although they still expect higher interest rates in Australia as well as a stronger currency.

"A rising AUD through to the end of 2021 and 2022 remains our central thesis," says Bill Evans, Chief Economist at Westpac.

Westpac holds a theme for 2022 and 2023 that increasing vaccination rates backed by record fiscal and monetary stimulus (albeit with some scaling back); and strong household balance sheets boosted by high asset prices will favour "risk on" currencies, of which the Aussie Dollar is considered.

But given the nature of the Covid Delta variant, "this transition to a world of sustained recovery will continue to be bumpy," acknowledges Evans.

Trend of weakness in AUD

Above: The strong trend of weakness in AUD is evident in GBP/AUD (top) and AUD/USD (bottom).

Owing to the increased uncertainty, economists at Westpac have lowered their GDP growth forecasts for the world and for China.

This has in turn fed into a lower forecast profile for the Australian Dollar (more on the forecast changes below).

"Once currency markets absorb significant data changes (such as the big shift in the iron ore prices over the last five weeks) there is usually an extended period of stability. We expect that we are
now entering that period although strategists are pointing to ongoing short term downside risks for AUD," says Evans.

One source of potential near-term support for the currency is the strong demand for Australian commodities and the strong prices they command.

On a month average basis Westpac find Australia’s current export commodity price Index is around 50% higher than it was a year ago near 10 year highs.

"Recall that when Australia last enjoyed such high commodity prices the AUD was trading near parity with the USD," says Evans.

However the difference between now and the the previous episode of high commodity prices is the Reserve Bank of Australia's (RBA) policy settings are very different: interest rates are now at record lows now, they were world-leading back then.

This suggests the Australian Dollar tends to only really benefit from high commodity prices when those commodity prices are fuelling strong economic growth and commanding high interest rates at the RBA.

The RBA has little incentive to raise interest rates from 0.10% as the economy is laden by a crippling New South Wales lockdown.

The ongoing pandemic situation means the Australian Dollar is the laggard of the G10 when screened over a one-month timeframe:

AUD is worst performer of past month

Above: AUD has lost ground to all its peers over the past month.

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"Factors behind the sharp deterioration in the AUD included the record 14% fall in the iron ore price on Thursday (marking its fifth weekly decline); data disappointments from China on retail sales and industrial production; and ongoing concerns about Australia’s battle with the delta virus," says Evans.

The Pound-to-Australian Dollar exchange rate has nevertheless retreated from a 2021 high at 1.9154 over recent days as investors unwind some of their bets against the Australian Dollar.

Selling the Australian Dollar has become an increasingly popular bet amongst traders, but an improvement in global investor sentiment this week has given reason to book profit on the trade and opened the door to a bounce in the Aussie.

The Australian-to-U.S. Dollar exchange rate has recovered from last week's low at 0.7105 to 0.7256.

Indeed, the Aussie's comeback serves as a reminder that it is driven by two things: 1) global sentiment and growth prospects and 2) the domestic environment.

The domestic outlook remains resolutely unconstructive for the Australian economy given the ongoing transmission of Covid-19 cases, particularly within the New South Wales (NSW) region where a new record case count was reported on August 25.

919 cases were reported in NSW while Victoria recorded 45 new cases.

Given the highly transmissible nature of the Delta variant it can be expected that the virus is likely to extend to other regions of the country.

Queensland said on Wednesday they would pause arrivals from New South Wales, Victoria and the ACT, with premier Annastacia Palaszczuk saying the state had been "overwhelmed by new arrivals relocating to escape interstate lockdowns".

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The country is still in the early stages of the outbreak and more negative headlines are likely to emerge which will dampen sentiment towards the Aussie Dollar in the near-term.

Westpac have downgraded their forecasted peak for the AUD/USD exchange rate as a result saying the end point for the AUD/USD in 2021 has been lowered from 0.78 to 0.75.

Increased uncertainty over the outlook has meanwhile flattened and extended the profile for the AUD/USD from a 0.82 peak in 2022 to a peak in 2022 of D0.78.

But, as risks, specifically around the pandemic, dissipate further, including in less developed economies, in 2023, Westpac say they expect AUD/USD to reach 0.80.