Australian Dollar Forecast @ 0.67 by the End of the Year: BNP Paribas

More interest rate cuts from the Reserve Bank of Australia will be needed to continue the job of rebalancing the economy away from mining analysts argue.

BNP Paribas are forecasting 2016 to be a negative year for the Australian dollar, based on the assumption that trade with China will deteriorate further.

"Our economists highlight that Chinese growth continues to shift away from the manufacturing sector towards the service sector, and continuation of two-speed growth in China will not be supportive for Australian export prices," says Sam Lynton-Brown at BNP Paribas.

The report comes on the day that official statistics showed Australia's trade deficit increased to A$-3.54bn in December from A$-2.73bn in November, knocking straight out of the park analysts’ forecasts of a narrowing to A$ -2.45bn.

The Australian dollar suffered notable falls as a result confirming the currency's link to trade numbers.

It is the fourth deepest deficit since the start of the data series back in 1970, with the other notable lows occurring in 2008, and then two other in 2015.

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The increase in the deficit came as the value of exports declined - by up to -5% in the case of Iron Ore, Australia’s biggest single export - and this outweighed the value of imports which also shrank, but by only -1.0%.

Furthermore, BNP Paribas FX Positioning Analysis highlights that short positioning in the AUD lags short positioning in the other G10 commodity exporter currencies: the NZD and CAD.

This suggests AUDUSD could fall sharply if sentiment turns more dovish on the outlook for the AUD.

"We forecast AUDUSD to decline to 0.67 by the end of the year," says Lynton-Brown.

The Re-Balancing Act is Yet to Convince

Australian authorities have been focusing a lot of attention on trying to rebalance the economy away from an over-reliance on mining and raw-materials to a more services-led model, but recent data suggests this has been met with limited success.

“The service PMI employment indicator has also remained below the 50 level for the fifth consecutive month. This reflects continued slack in the labour market. In our view the unemployment rate is likely to rise from 5.8% in December 2015 to above 6% in the coming months," says Roy Teo, Senior FX strategist with ABN Amro.

Australia’s service sector contracted for the fourth consecutive month in January, albeit at a slower pace.

"This is worrisome given that the Reserve Bank of Australia (RBA) is seeking to rebalance the economy from the mining sector to non-mining sectors," points out Teo.

More RBA Interest Rate Cuts Ahead, Forcing AUD Lower

ABN Amro also highlight the increasing slack in the services labour market, and makes a case for this impacting on Reserve Bank of Australia policy trajectory:

“The service PMI employment indicator has also remained below the 50 level for the fifth consecutive month.

“This reflects continued slack in the labour market. In our view the unemployment rate is likely to rise from 5.8% in December 2015 to above 6% in the coming months.”

ABN-Amro see a further 0.25% cut in the RBA’s base lending rate as a consequence:

“We maintain our view that the RBA is likely to lower the OCR by 25bp to 1.75% in May.

“We expect the Australian dollar to decline towards 0.62 by the end of this year.”

The slow-down in the critical services sector and the widening Trade Deficit see reasons for expecting a rate cut from the RBA multiplying.

According to WSJ's James Glyn the trade deficit figure alone is cause to expect a further rate cut:

“Economists said the data implied trade had contributed less to economic growth in the fourth quarter of last year than in the third, and may continue to weigh on the economy, increasing the risk that interest rates will need to be cut soon.”

And:

“Interest rates haven’t changed since May 2015, but with central banks globally moving to announce more stimulus to boost their economies, the RBA is under pressure to cut again.”

Building Permits Surge  

Not all aussie data has been negative, however, and an antidote came in the form of Building Permits, which were released at the same time as the Trade Deficit, but which showed an encouraging 9.2% rise in December, from a much lower -12.4% fall in

November, and beating estimates of a 4.5% rise.

The year-on-year data, however, continued see Building Permits fall, at a pace of -2.5% against 7.2% expected and -7.6% prior – a recovery but not a stellar one.

The uneven pace of house price rises in Australia has seen stratospheric rises in large cities but not outside, leading to the RBA considering macro-prudential rules on mortgage lending, as have been implemented by RBNZ in New Zealand to prevent the bubble in Auckland.

RBA Cools on Rate Cut

Tuesday’s RBA rate statement from Governor Glenn Stevens was actually slightly hawkish, indicating the central bank was not close to cutting rates.

The depressing trade data had not yet been released; and on Services sector growth, they were quite positive, unlike ABN-Amro:

“In Australia, the available information suggests that the expansion in the non-mining parts of the economy strengthened during 2015 even as the contraction in spending in mining investment continued. “

They saw housing bubbles in Sydney and Melbourne easing:

“The pace of growth in dwelling prices has moderated in Melbourne and Sydney over recent months and has remained mostly subdued in other cities. “

Overall it did not seem as if they were close to cutting rates.

Much now depends on how much impact the trade deficit data has had on their analysis and outlook, as to whether it could markedly alter their stance.