The Pound to Australian Dollar rate could extend losses if UK rate bets are pared while the RBA tightens.
The Pound to Australian Dollar exchange rate faces further downside as investment bank analysts question UK rate hike expectations ahead of next week's Reserve Bank of Australia (RBA) decision.
GBP/AUD trades at 1.8788 at the time of writing, down from 1.8907 at the end of August, and the pair's direction now rests on the gap between the rate hikes markets expect from the Bank of England (BoE) and those they expect from the RBA.
Money markets price around four BoE hikes by July next year.
"In our view, a paring of those rate hike expectations will weigh on GBP/USD," says Commonwealth Bank of Australia (CBA).
The same repricing transfers weight onto GBP/AUD, where Australian rates are expected to keep rising.
Markets price close to a 90% chance of an RBA hike on 29 September, and ANZ expects the cash rate to keep rising beyond that.
Governor Michele Bullock recently described Australia's labour market as "a bit tight, while the verdict from the Bank of England is that the UK labour market gives it no equivalent pressure.
Above: Market-implied path for Aussie rates.
CBA expects a single 25 basis point BoE hike in November, with Bank Rate already in restrictive territory and a soft UK labour market limiting the pass-through of higher energy prices.
That leaves the UK case for hikes dependent on energy.
CBA expects the Strait of Hormuz to reopen within five to ten weeks, lowering energy prices and removing "one major source of inflation."
"Ultimately, any policy tightening remains state-contingent on the energy price outlook," says Sanjay Raja, economist at Deutsche Bank, of the BoE.
Deutsche Bank expects two insurance hikes, in November and February, half of what markets price.
The RBA's concern, by contrast, centres on domestic pressures that lower oil prices do not resolve, leaving Australian rate expectations better protected than UK ones.
Daniella Arcadipane, Senior Currency Specialist at Indigo
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Talk to a specialistThe UK Fiscal Squeeze
Brown Brothers Harriman (BBH) points to a second source of downside for UK rate expectations. "A tighter UK fiscal squeeze suggests the BOE may not need to raise the policy rate as much as markets expect," says Elias Haddad, Global Head of Markets Strategy at BBH.
This after the government borrowed £18.3bn in August, £3.5bn above the Office for Budget Responsibility forecast.
Higher borrowing costs are estimated to have halved fiscal headroom to around £12bn, leaving Chancellor John Healey under pressure to raise taxes and cut spending at the 28 October Budget.
Markets price 100 basis points of BoE tightening over the next twelve months, taking Bank Rate to 4.75%.
Haddad says GBP "is vulnerable to a dovish BOE repricing."
"With so little data before November, pricing can only really move one way," says Thanim Islam, Head of FX Analysis at Equals.
The RBA Leans the Other Way
Speaking on a podcast, RBA Assistant Governor Sarah Hunter recently said the decision to hold at the last meeting did not signal complacency.
"The board were pretty clear that even though they didn't hike the cash rate, they are still very concerned about inflation," says Hunter.
Bullock warned that inflation expectations risk becoming embedded.
CBA expects the RBA to signal next week that it remains willing to raise the cash rate again if needed, "which can boost AUD/USD."
AUD/USD trades near 0.7120, holding above the 200-day moving average band at 0.7040 to 0.7010 identified by Societe Generale.
With a hike close to fully priced, a hold on 29 September is the pound's best chance of lifting GBP/AUD back towards 1.89; a hike alongside a hawkish signal opens the way below 1.8750.
Daniella Arcadipane, Senior Currency Specialist at Indigo
Moving a life-changing sum abroad? You won’t be doing it alone.
One specialist explains every step in plain English and stays with it until the money lands. FCA authorised, FRN 594433.
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