Australian Dollar Forecasts Lowered at RBC Capital

- AUD forecasts lowered by RBC Capital
- See confluence of unsupportive developments
- But, GBP/AUD forecast notably lower

Australian Dollar forecast RBC Capital

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The Australian Dollar is pointed lower shows new research from international financial services provider and investment bank RBC Capital Markets.

"Fundamentals point down," says Elsa Lignos, Head of FX Strategy at RBC Capital Markets, "AUD is unlikely to recoup its status as the G10 high yielder any time soon."

The Australian Dollar has proven to be an underperformer in 2021, falling against all but three of its G10 peers.

Factors contributing to this weakness include extended domestic Covid lockdowns and slowing Chinese growth.

This has lead the Reserve Bank of Australia (RBA) to indicate it is unwilling to raise interest rates from crisis-era lows in the foreseeable future, depriving the Australian Dollar of the interest rate advantage it had enjoyed heading into the Covid crisis.

But digging into the fundamentals Lignos finds that Australia had in fact been suffering deflationary focus ahead of the pandemic, suggesting to her that deeper structural issues are at play.

Australian Dollar valuations

Above: "Fundamentals point to AUD/USD lower" - RBC Capital Markets.

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RBC's economists find the inflation trend in Australia to be different to the rest of the world, with wage inflation in particular looking softer.

"A disinflationary trend was already evident in Australia pre-pandemic, prompting cuts from the RBA in 2019," says Lignos.

The central bank would only likely raise interest rates in response to signs the economy is generating inflation via strong economic growth.

Higher central bank interest rates would meanwhile prompt higher returns on Australian financial assets, such as government bonds, which entices supportive inflows of foreign capital.

The Australian Dollar benefited from such dynamics through the 2010's, but this advantage has since disappeared with the RBA lowering interest rates to record lows.

The market is however currently pricing in an interest rate rise at the RBA in 2022 judging that the country's roadmap out of lockdown will generate a growth rebound.

Yet the Australian Dollar has hardly reacted to this seemingly bullish development.

"Longer-term, AUD is unlikely to recoup its status as the G10 high yielder any time soon. The RBA will be constrained in its capacity to act, even when they eventually get going," says Lignos.

RBC's economists anticipate the eventual upper limit of any Australian interest rate rises will be in the 1.5% area, lower than in previous RBA hiking cycles.

"That is down to greatly increased household indebtedness, with mortgages that are primarily priced off variable rates," says Lignos.

Turning to commodities, a traditional source of support for the Australian Dollar, RBC Capital note surging natural gas prices should prove supportive.

But, falling iron ore prices in response to slowing Chinese growth will likely weigh.

"Iron ore exports are worth around twice as much as coal/LNG which is worth bearing in mind," says Lignos.

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RBC Capital say they have revised down their longer-term forecasts for the Australian Dollar as a result.

The bank holds a forecast point target of 0.72 for the Australian-to-U.S. Dollar exchange rate for year-end 2021.

The forecast for the end of the first quarter 2022 is 0.71, 0.70 for the end of the second quarter, 0.69 for the end of the third quarter and 0.69 for year-end 2022.

For the Euro-to-Australian Dollar exchange rate the point target forecasts are 1.58, 1.59, 1.60, 1.64 and 1.65 respectively.

Utilising RBC's GBP/USD forecasts of 1.30, 1.26, 1.22, 1.23 and 1.23 we can arrive at a cross forecast for the Pound-to-Australian Dollar exchange rate of: ~1.8055, ~1.77, ~1.74, ~1.78 and ~1.78.

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