FX comment – AUD higher as RBA maintains neutral bias…for now

by: Roy Teo

  • AUD higher as RBA maintains neutral bias
  • Some bright spots in the economy…
  • …headwinds remain…
  • …further monetary stimulus warranted
  • Weaker AUD/USD to around 0.60 in 2016


AUD higher as RBA maintains neutral bias

The Australian dollar (AUD) rose by about 30 pips to above 0.7110 after the Reserve Bank of Australia (RBA) left monetary policy unchanged at 2% this morning. Though this is widely expected, financial markets were positioned that the RBA will be dovish. However the RBA’s outlook for both the domestic and global economy was largely unchanged from the previous monetary statement. In addition, the RBA ‘comfort’ that the AUD is adjusting to the significant declines in key commodity prices remains intact.


Some bright spots in the economy…

Since the RBA lowered the OCR by 25bp to 2% on 5 May and shifted to a neutral bias, the AUD trade weighted index has declined by about 8%. As a result the AUD is less misaligned with Australia’s key commodity export prices, reducing the RBA’s dovish tone on the exchange rate. There are also encouraging signs that both the manufacturing and service sectors are benefiting from the accommodative monetary conditions and weaker exchange rate. In addition, the job market is also showing some signs of stabilization.


…headwinds remain…

Having said that, headwinds to the economy remain. Though business conditions have improved, business confidence has deteriorated due to more grey clouds surrounding Australia’s trading partners, including China. Indeed, the cumulative trade deficit in the first 8 months of 2015 is the widest since data was compiled in 1971. Since the first quarter of 2014, corporate profits have also been declining. In addition, consumer confidence is weaker than before the RBA last lowered the OCR in May. Weak consumer and business confidence are expected to weigh on consumer spending and business investments respectively. In addition, despite some stabilization in the job market, wage growth remains weak. Auction clearing rates imply that house price inflation is expected to moderate. Macro prudential tools implemented by regulators to reduce risks in the housing market have also resulted in slower housing credit growth for both house owners and investors.


…further monetary stimulus warranted

On balance, we expect economic growth in Australia to remain below trend rate well into 2016. A slower Chinese economy and weak commodity prices will remain headwinds to Australia. We expect non-tradable inflation to ease lower due to soft labour market and moderating house price inflation. As non-tradable inflation accounts for 60% of CPI, inflation in the third quarter is expected to ease lower despite a recovery in tradable inflation. A weak Q3 inflation print (28 October) will reignite market expectations that the RBA could lower the Official Cash Rate in the next monetary policy meeting on 3 November. This is not fully priced in by financial markets.  We also think that it is necessary for the RBA to increase monetary stimulus to anchor inflation expectations (implied by the bond market) which is weaker than in May.


Weaker AUD/USD to around 0.60 in 2016

We expect the RBA to keep monetary policy accommodative well into 2016 as inflation is expected to remain within the 2-3% target next year. As the US Federal Reserve continues to tighten monetary policy next year, narrower interest rate differentials is expected to exert downward pressure on the AUD/USD towards 0.60 by the end of 2016.