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Australian Dollar Catches New Bid but Monday’s Finance Update Will Test Appetite

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Borrowing forecasts in Monday's fiscal update could influence the AUD/USD bond spread and thereby, the Aussie Dollar, either clipping or boosting its recent gains.

The Australian Dollar has advanced relentlessly against the G10 basket as traders continue to reward a solid November jobs report with a steady bid, although the government’s mid-year fiscal update will test the market’s appetite for the Aussie currency Monday.

Australia’s economy added 61,600 new jobs in November, up from 7,800 in October and far ahead of the consensus estimate for 18,100 new jobs to have been created during the period.

The jobs data helped to firm up earlier gains, made after the unveiling of the largest merger in Australian corporate history, the completion of which is expected to bring around $5 billion US Dollars of inflows into the country.

“AUD/USD has held on to yesterday’s gains following the combination of a softer USD after the FOMC rate hike, the strong Australian November employment report, and some reasonable Chinese activity data for November,” says Richard Grace, chief currency strategist at Commonwealth Bank of Australia.

Australia’s Dollar was quoted 0.23% higher at 0.7682 against the greenback during early trading in London Friday while the Pound-to-Australian-Dollar rate was called 0.23% lower at 1.7482.

Above: Pound-to-Australian-Dollar rate shown at hourly intervals.

“We anticipate further gains in AUD/USD as market participants assess that a narrow Australia-U.S. two-year bond spread is really only a headwind now that Australia’s current account deficit has structurally narrowed, and strong global growth lifts commodity prices, and as Australia’s economy improves,” adds Grace.

Commonwealth’s Grace flagged Friday that the gap between Australian/US two-year bond yields has risen back into positive territory, by +9 basis points, reversing an earlier inversion that put pressure on the Aussie Dollar.

Interest rate differentials are important drivers of currency prices as higher rates in one country, relative to those elsewhere, can attract foreign investors who have to buy the relevant currency in order to exploit the higher returns available from the bond market of the country in question.

Grace reiterated Commonwealth’s end of year target for the AUD/USD rate Friday which, being set at 0.7800, implies 1.5% upside over the next fortnight.

Above: AUD/USD rate shown at daily intervals.

However, appetite for the Aussie Dollar may be tested again Monday when the government releases its latest mid-year economic and fiscal update.

Not only will this provide investors with an insight into Treasury expectations for the economy, it will also bring details of what Aussie officials expect their borrowing requirement to be over the coming months.

The borrowing requirement is important because it has implications for the supply of Australian government bonds which, in turn, has implications for Australian bond yields.

“The government is likely to keep economic forecasts pretty much where they were at the May Budget Economic,” says John Peters, a senior economist at Commonwealth.

“We expect some reduction in expected 2017/18 Budget underlying deficit of $29.4bn (~1.6% of GDP) to around $27bn. Revenue gains from commodities are undermined by weak wages. But jobs growth has picked up.”

Australian economic growth has picked up in 2017 and the labour market tightened, helping the currency to recover from the slump seen during the commodity price downturn, which forced the Reserve Bank of Australia to cut the Aussie cash rate to a record low of 1.5%.

Evolving expectations of where the cash rate goes next, and when they eventually move, will be key to the Aussie Dollar outlook in 2018. Interest rate expectations themselves will be determined largely by what happens in the Aussie labour market - particularly around wage growth.

“Our base case has inflation remaining soft due to elevated slack in the labour market which is suppressing wages growth. We have core inflation tracking at the bottom of the RBA’s target band (chart 3). This means that a rate rise still looks a long way off,” says Commonwealth’s Peters.

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