Currency & Rates at Commonwealth Bank of Australia

Richard Grace, Strategist: Currency & Rates at Commonwealth Bank of Australia, on AUD

While the RBA has reduced its economic growth forecasts for the current financial year by half a percentage point, it expects growth to pick up to between 3% and 4.5% by December 2017. Do you anticipate these forecasts to be reached, given the commodity and dairy prices?

It may be a little bit optimistic, but there is in fact a forecast that trend GDP growth is going to return. Currently it is a little bit lower than it was, arguably even below the 3% (around 2.75%). However, even if we call at 3%, I believe the main driver is going to be the non-mining business investment, which will help list-aggregate demand to go higher. Australia at that point in time will become the world’s largest gas exporter with the least volumes from being the world’s fourth largest gas exporter, whilst net exports will continue to drive the Australian GDP growth ahead, as it has for some time, but probably in a more forceful fashion. I think it is possible that we will see some stronger GDP numbers come through by the end of 2017, but whether there is high of what the RBA is anticipating at this time remains to be seen.

The Reserve Bank of Australia expects that the depreciation of the Aussie would support demand for Australian production and add to inflation pressures for a time through higher import prices. Do you anticipate the central bank to prove right in the foreseeable future?

The RBA view is that the unemployment rate is taped in, and that is plausible, however, it is quite good at the given moment. Some of the service industries, for example tourism, are growing quite rapidly and they are much more labor-intensive than other parts of the economy. However, the GDP itself will be very much dependent from net exports, which will likely continue to rise, as the last part of the mining investment downturn runs its course, which just by definition will make imports fall. This will happen mostly due to about 50% of the mining investment activities important items and as the mining investment stops, it will happen at the same time with gas exports being switched on, since the LNG gas is really the bulk of the mining investment activity.

Governor Stevens seemed particularly pleased with recent jobs growth, and refrained from repeating his concerns about the AUD being overvalued. What to your mind is the fair price of the Australian Dollar? What other major headwinds for the Australian Dollar could you mention for the end of the year?

In regards of the Aussie value, I would say it is around 73-74 cents levels, which is fair value at the moment. However, it is probably going to drop down to around 70 cents by the first quarter of 2016, led by declining commodity prices, continuous extra supply and below-trend global GDP growth. These are going to combine to drive commodity prices a little lower in Australia’s terms of trade, income activity in the economy and aggregate GDP growth below trend.

Another driver will be the Fed rate hike, knowing the Australia US interest rates differentials that will continue to put some downward pressure on the Aussie. Moreover, further softening in the Asian currencies is likely to take place, since when they depreciate – the Australian Dollar goes down hand in hand, since Australia’s exports 76% of its good to Asia. Also, we anticipate a modest near-term widening in the country’s current account deficit, which is going to put some downward pressure on the national currency. However, in a longer term, we believe that the current account deficit will improve.

Talking about the RBA, dropping its terminology for the AUD to fall lower – in my view that is due to the Aussie has a bit of caught up with the falling commodity prices at the moment This will be the major concern if we take a look at the RBA internal exchange rate model has the terms of trade and real interest rate differentials, what appeared to be a fall in the Australian Dollar relative to the fall in the terms of trade. However, that seems to have close now, whilst I believe this is why the central bank is much less vocal about saying depreciation of the AUD is most likely and necessary.

What are your short and long-term forecasts for AUD/USD, AUD/NZD and AUD/JPY?

For the AUD/USD pair our forecast is 0.73 for the end of September and 0.72 for the end of December, whereas we expect the pair to reach 0.70 in March 2016. I think there is a reasonable chance that the Australian Dollar will get below 0.70, but we expect it recovering by the end of the particular quarters to the levels mentioned.

As concerns the AUD/NZD, our scenario is 1.1406 by end of September and our December estimate is 1.1429. Finally, we anticipate seeing the AUD/JPY trading at 89.79 in Q3 and 99.94 for the end of 2015.