Powered by higher commodity prices, the Australian dollar continues to go from strength to strength, even with a small stumble today.
Such has been the scale of it’s recent surge, seeing it hit the highest levels in over two years late last month, it’s got a lot of forecasters scrambling to reassess their prior forecasts for substantial weakness in the years ahead.
Westpac are among that group, and, like an increasing number of other analysts, they’ve been forced into a change, revising up their Australian dollar forecasts for the next 18 months today.
“The rally in commodity prices and associated currency market reaction has seen us revise our near-term outlook for the Australian dollar higher,” said Bill Evans, chief economist at Westpac.
“In retrospect, our expectations for the extent of the reversal in commodity prices were overdone with the expected falls in 2018 in line with the proportional corrections we saw in 2015, when the authorities took a particularly hard line against corruption and debt fuelled excess.
“The ferocity of the policy reversal in 2016 now indicates that Chinese authorities recognise that the policies through 2014 and 2015 were excessively tight and would be unlikely to repeat such an exercise. Further, we expect that through the remainder of 2017, policy will continue to tighten but at a modest pace.”
Given that expectation, Westpac now sees its Australian commodities index only falling by 7% by the end of this year, a sharp upward revision to it view that commodity prices would fall 30% in the second half of the year.
As such, it now sees the AUD/USD finishing the year at 76 cents, above its previous forecast for a decline to 73 cents.
Looking further ahead, Evans’ says that interest rate differentials will continue to undermine the Aussie, although not as much as first thought.
“We see quite a different configuration for interest rate differentials by the end of next year than is currently priced into the market,” he says.
“Markets are anticipating only one more hike by the Federal Reserve through end 2018 while we are maintaining our call for three, with the next move coming in December to be followed by June and December next year.
“On the other hand, markets are pricing in around one 0.25% rate hike by the RBA next year whereas we expect rates to remain on hold.”
Markets currently price that Australian interest rates will be 0.4% above those in the US by the end of 2018, while Westpac sees Australian interest rates around 0.4% below the US over the same time period.
Despite losing support from its yield advantage over the greenback, Evans says a slower decline in commodity prices will cushion the Australian dollar’s decline, seeing it finish 2018 at 70 cents, up from the bank’s prior forecast for a larger decline to 65 cents.