AUD: Dose of reality? - Rabobank

It the market needed further convincing that the RBA is set to keep policy on hold for some time, it came in the form of the softer than expected Q1 CPI data release this morning, according to Jane Foley, Senior FX Strategist at Rabobank.

Key Quotes

“The headline rate registered 1.9% y/y, below the 2.0% y/y consensus forecasts and outside the central bank’s 2% to 3% target band.  AUD/USD is currently trading off the day’s low, encouraged by a better tone in iron ore prices.  That said, AUD/USD has fallen sharply in recent sessions and is currently trading around 2.7% below last week’s best levels.  Measured from its January high, AUD/USD has plunged around 6.5%.”

“Looking ahead, the RBA will have to strike a balance between the different price pressures across the country.  Policy makers currently appear to have plenty of breathing room, though it is hoped that spare capacity will continue to diminish in the months ahead as the economy continues to strengthen.”

“Australia shares the characteristic of very low wage inflation with many other G10 economies. However, unlike some other major central banks the RBA lacks pressure to normalise policy.  Aside from the fact that CPI inflation remains below target, this is probably a function of several additional factors.  Firstly, RBA rates still has some room for manoeuvre of the downside meaning there is less pressure “to fix the roof when the sun is shining”. Due to the ability to the Australian economy to avoid recession during the financial crisis years, the RBA has never been involved in QE, this also means there is less need to normalise policy.  Thirdly, on many measures the AUD is still overvalued meaning the RBA may be better served to delay a rate rise on the hope that interest rate differentials will put downside pressure on the AUD.”

Aside from rate spreads, there are others clear influences on the AUD. Commodity prices have a strong influence.  Commodities such as iron ore and copper can in turn be seen as proxies for the level of activity in China.  Australian government forecasts have been bearish on iron ore in 2018 on the back of expectations of strong output from Australian and Brazil and the possibility of moderating demand from China.  Measured from its January high, iron ore is currently trading around 17% lower, with prices comfortably off this month’s weakest levels.  In the month ahead Chinese demand could be impacted by factors such as trade wars and domestic policies aimed at curbing pollution meaning the outlook could prove to be particularly hard to predict.”

“Assuming moderate demand from China for commodities and steady policy from the RBA at least through the remainder of this year, we expect AUD/USD to end the year in the 0.75 area.”