Australian Dollar Forecast to Enjoy 7% Advance on Pound and US Dollar say Commonwealth Bank of Australia

- AUD/USD seen rising 7% in 2018, GBP/AUD to fall 8%.

- Strong Aussie fundamentals and weakness elsewhere are key drivers.

- Key risks are a slower than expected RBA and "trade war" fears.  

CBA exchange rate forecasts

Image © Pound Sterling Live

The Australian Dollar is forecast to rise against its US and British rivals over the coming quarters, according to forecasts from Commonwealth Bank of Australia, with the only uncertainty being the likely pace of the Antipodean currency's gains.

There is almost equal upside for Australia's Dollar relative to both the US greenback and Sterling, at around 7% each, if Commonwealth's latest numbers prove correct although there is also a series of domestic and international risks that might slow the pace of its advance during the months ahead.

"We continue to expect AUD/USD to edge higher towards year-end," says Elias Haddad, a senior foreign exchange strategist at Commonwealth. "As a refresher, there are four pillars supporting our constructive outlook."

A "fundamental US Dollar downtrend" is expected to help the Australian Dollar climb against its American rival this year, according to Haddad, as the market is already banking on about as many interest rate rises as the Federal Reserve ican possibly deliver. This means there is little to be gained by the Dollar from each incremental economic success as these will be unlikely to mean the US central bank moves any faster. 

"And there is greater scope for less monetary policy accommodation from other major central banks, which is not fully discounted," Haddad notes, alluding to the possibility that markets could soon begin betting that other central banks either begin to raise interest rates, or pick up the pace at which they are withdrawing so called "policy accomodation".

The Reserve Bank of Australia (RBA) and Bank of Canada (BoC) are two prime examples of central banks that could adjust their monetary policy settings in a way that would have positive implications for their respective currencies. After all, markets do not anticipate that the RBA will raise its interest rate until well into 2019 while the BoC begun its own hiking cycle in 2017 although markets are uncertain when the next rate rise will come.

"Yield curve differentials already point to stronger Australian economic growth prospects relative to the US. This combined with point 4 below partly explains the resilience of AUD/USD to negative Australia-US interest rate spreads," says Haddad, after drawing attention to the favourable Australian economic growth outlook.

The Reserve Bank of Australia has said domestic GDP growth will be in excess of 2.75% over the next couple of years, according to Haddad, or above its so called "potential rate". Until March the RBA's official forecasts were for growth to be above 3% in both 2018 and 2019, although its latest line is that growth will be "faster than in 2017". Australia's economy grew by 2.4% last year. 

Faster global economic growth in 2018 can also support the Australian Dollar, according to Haddad, given its ability to influence commodity prices. This could have positive implications for Australia's "terms of trade", which measures the value of a country's exports relative to its imports and provides insight into a nation's purchasing power. An improving "terms of trade" is synonimous with an improvement in the fundamental value of a currency.

"By historical standards, Australia’s current account deficit is small at just 3% of GDP and forecast to average 2% of GDP over the next few years. Importantly, the current account deficit is currently entirely offset by net foreign direct investment flows to Australia totalling 3% of GDP. This is indicative of robust underlying demand for AUD," adds Haddad.

Haddad and the Commonwealth team cite these above factors as grounds to think their Australian Dollar forecasts will pan out over the coming months, although they acknowledge a series of risks to their numbers.

"We currently anticipate the RBA to raise rates by 25bps to 1.75% in November. But soft Australian inflation pressures suggest the RBA can afford to stay on the sidelines for a while longer. Australian interest rate futures place less than a 30% probability of a November RBA rate hike," the strategist writes, in a note Wednesday.

The Reserve Bank of Australia has held its cash rate at a record low of 1.5% for the almost two years and will not be able to raise it until Australian inflation, which is currently at 1.9%, makes a sustainable return back toward the midpoint of its 2% to 3% target band. There are few signs that this will happen any time soon.

"Judging from Australia’s elevated underemployment rate, there is still plenty of labour market slack left in the economy. This means wage pressures are unlikely to accelerate enough to drive inflation significantly higher," says Haddad.

Another important factor for the Aussie will be the global risk environment. Risk currencies like the Australian Dollar and assets such as stocks were forced onto the back foot in March and early April as markets became concerned about the prospect of a so called trade war between the US and China.

Although a series of conciliatory remarks from both China and the US led to an easing of tensions this week, an escalation of tit-for-tat tariff measures and renewed tensions later in the year cannot be ruled out. This would be bad for the Australian Dollar.

"Overall, of these risks identified above, we are more concerned about a delay in the RBA’s interest rate normalisation cycle," says Haddad. "Consequently, Australia’s Q1 CPI report will be a major determinant guiding our AUD outlook. Another muted underlying CPI inflation print could convince us to modestly trim our bullish AUD/USD projections."

Haddad and the Commonwealth team forecast the Australian Dollar will rise to 0.83 against the US Dollar before year-end, which implies upside of just more than 7% from Wednesday's 0.7750 level. 

The Pound-to-Australian Dollar exchange rate rate is predicted to fall by just more than 8% from Wednesday's 1.8299 to 1.7108 before 2018 draws to a close.

Get up to 5% more foreign exchange by using a specialist provider to get closer to the real market rate and avoid the gaping spreads charged by your bank when providing currency. Learn more here.