Australian Dollar is on the Ropes but it Can Still Triumph in 2018

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Strategists are increasingly revisiting their calls for an RBA rate hike in the first half of the year and downgrading their Australian Dollar forecasts, but the currency can still triumph in 2018.

The Australian Dollar is facing increasing headwinds in the months ahead now the short term interest rate outlook has deteriorated, according to Maybank in Singapore, although it can still rise against the US Dollar in 2018.

Strategists have become increasingly cautious in their outlook for the Australian Dollar over recent days, and downright pessimistic on the question of Australian interest rates, after a duo of disappointing developments on the Aussie wages and inflation fronts.

“In an environment of USD resurgence and possibly slower creep up in wage growth, we see risks of bears extending their stay and the recovery in the AUD to be a little delayed,” says Saktiandi Supaat, an analyst at Maybank in Singapore.

Wednesday’s December quarter wages report left a sour taste in the mouths of traders, despite a better than expected figure for the period, as it showed the lion’s share of wage pressure coming from growth in public sector pay packets that are likely to be stifled by new regulations in coming years.

Australian wages grew by 0.6% during the fourth quarter of 2017 when markets had pencilled in a lower rise of 0.5%, while annual pay growth was a healthy 2.1%.

However, wage packets grew by only 0.5% in the private sector during the quarter and by 1.9% on an annual basis, against a larger 2.4% increase in the public sector earnings.

This is a problem because its shows private sector pay growth stuck close to Australia’s all time low of 1.9% and Prime Minister Malcolm Turnbull's government has recently said it will push ahead with plans to cap future public sector pay rises at 2%.

“That could mean lower wage growth for public sector jobs (which typically surpasses those in the private sector) and a slower creep up in general wage growth,” adds Supaat.

Wage pressures, and labour markets by implication, are the most important macroeconomic variables in the global interest rate equation at the moment given their significance for inflation.

Central banks can only raise interest rates in response to changes in inflation pressures, while it’s expectations of higher or lower interest rates that dictate the respective fates of the currencies tied to them.

The Reserve Bank of Australia held its cash rate at a record low of 1.5% for the 19th month in a row this February and pricing in interest rate derivatives markets currently implies that rates will remain here until well into 2019.

Wednesday the International Monetary Fund urged Australia to keep its interest rates low and broader monetary policy stimulatory until inflation and domestic demand pick up to more healthy levels, which could take some time.

“That has exacerbated the AUD weakness, especially against the USD which seems pretty dominant at this point as we head into ECB Minutes and the publication of Jerome Powell’s first semi annual testimony to the congress this Fri,” Supaat says. “The line-up of events makes AUDUSD look particularly vulnerable at this point.”

Australia’s fourth quarter inflation report also left a lot to be desired, with both headline and core consumer prices remaining static at 1.9% when they had been expected to rise. The Australian inflation target is to keep consumer price growth within a 2% to 3% range.

Given the deteriorating outlook for wage growth and thus, inflation, strategists are increasingly downgrading their Australian Dollar forecasts and revisiting their calls for an RBA rate hike in the first half of the year.

Wednesday saw strategists at TD Securities drop their call for a Reserve Bank of Australia rate hike in May, citing a “gradual theme” at the central bank and a deteriorating outlook for inflation.

The FX team at Deutsche Bank also joined the choir of bearish forecasters opining on the Australian Dollar Wednesday, saying the AUD/USD rate is in danger of a fall toward the 0.75 level as expectations for a rate hike slip further.

"Of course, getting to 75c is tough given there’s a soft USD thematic to fight, and the global picture (commodities, EM equities) is supportive. But we are happy to remain sellers on any move above 80c," says Tim Baker, a strategist at Deutsche Bank.

Maybank revised its forecast for the AUD/USD exchange rate at the end of the first quarter 2018 lower Thursday, from 0.80 to 0.7850, which is a fraction above the market price of 0.7814 at the time of writing. 

“We see downside risks to 1Q AUDUSD forecast at 0.80 as well as our call for RBA to hike in May,” says Supaat. “That said, we are not turning bearish in the AUD, merely expecting the AUD bears to stay a little longer.”

However, Maybank still predict the AUD/USD rate will rise notably over the course of the 2018 year, reaching 0.83 by the end of December. This is down from the bank's earlier 0.85 forecast but implies more than 5% upside from current prices.

The AUD/USD rate was quoted 0.24% higher at 0.7814 Thursday while the Pound-to-Australian-Dollar rate was 0.57% lower at 1.7737.

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