Australian Dollar Could See More Pressure Against Sterling as Interest Rate Differential Narrows

GBP/AUD is recovering lost ground as data releases in Australia and the United Kingdom head in opposite directions.

The Australian Dollar slid broadly against the G10 basket Friday, with some of its steepest losses coming relative to the Pound, after data appeared to show divergence in the relative economic fortunes of the UK and Australia.

September’s Australian retail sales data drove weakness in the Dollar, after sales growth stalled at 0.0% following two months of contraction, while PMI numbers emerging from the UK for October pointed toward an economy that has regained some of its lost momentum in recent months.

"It was a clean sweep of improved headline numbers across the sectors in the October PMIs," says Sam Hill, senior UK economist at RBC Capital Markets, of the UK data. "Our PMI-based GDP indicator suggests that if these levels were to prevail for the rest of 2017, Q4 GDP growth would be 0.5% q/q. This is significantly above our current forecast of 0.2%."

Aussie retail sales were expected to rise at a month-on-month pace of 0.4%, recovering some of the output lost in the contraction of recent months, but they stalled at their reduced level after aggressive price discounting hit the Dollar value of goods sold.

“The overall picture continues to be one of stalled demand and increasingly aggressive price discounting,” says Matthew Hassan, a senior economist at Westpac, of Australia’s retail sales. “ The 'saving grace' – for consumers at least – is that the fall was all due to a 0.4% decline in retail prices, the biggest quarterly drop since 2004.”

The Pound-to-Australian-Dollar exchange rate was quoted 0.80% higher at 1.7054 during the morning session in London.

GBP/AUD rate at hourly intervals. Captures Bank of England reaction and Friday's attempt at a recovery.

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“Retail price deflation looks to be firmly entrenched,” adds Hassan. “Basic food retail prices, which had been pushed up by weather events earlier in the year, have moderated with annual inflation in this segment back to 0.6% per year.”

Non-food retail prices in Australia are in decline, falling at an annualised pace of 1.9%, the weakest level of goods price inflation for 12 years.

“The widespread nature of retail price declines is also striking – 10 of the 14 different storetype and state retail deflators have seen back to back quarterly declines in prices in 2017, the highest proportion since the AUD driven price deflation in 2003,” Hassan notes.

The AUD/USD exchange rate was quoted 0.61% lower at 0.7666 Friday, reducing the pair’s 2017 gain to 6.5%.

AUD/USD rate at hourly intervals. Captures retail sales reaction and London morning.

Australia's retail sales numbers come closely on the heels of disappointing September inflation data, which showed both headline and core consumer prices trailing market expectations, leading underlying inflation pressures to be presumed missing-in-action.

“The CPI print was disappointing in more ways than one,” says Tony Morriss, a rates strategist and economist at Bank of America Merrill Lynch. “The Bank lacks a narrative to signal an eventual move to a more normal rates structure, at this stage, and front-end rates are set to hold ranges with monetary policy sidelined.”

Morriss forecasts a decline in support for the Australian Dollar given that expectations for a Reserve Bank of Australia rate hike are dwindling fast.

“While a weaker currency should keep open the option of a shift to a more optimal policy mix next year, the risk is that the RBA will stay on hold,” the strategist adds.

Markets have been betting that a gradual move toward a more normal interest rate environment by other central banks would draw in the RBA, with bond and interest rate derivatives prices indicating a modest expectation by some traders that the RBA might move early in 2018.

“We have pushed back our expected timing of what is likely to be a modest move to more normal levels and now see a start in May, says Morriss. “This is still earlier than the recent re-pricing in the local market now suggests.”

The Reserve Bank of Australia has held the cash rate at its record low of 1.5% for 14 months in a row amid concerns over the outlook for inflation and the impact that higher interest rates could have on debt-laden households and the economy.

“We concede that AU official rates at 1.5% did not get to levels seen in the major economies during the "race to the bottom" of global QE, but the longer that rates remain on hold, then the greater the number of marginal households that take on debt at the current level of rates will make any future adjustment more painful,” Morriss warns.

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