CBA: 5 reasons the Australian dollar will continue to slide

AUCKLAND, NEW ZEALAND – FEBRUARY 23: People enjoy the muddy thrills and spills on a waterslide dug into a hillside in Waimauku on February 23, 2013 in Auckland, New Zealand. Only 2000 people will have the honour of riding the water slides, with one measuring 650 meters long built by New Zealanders Jimi Hunt and Dan Drupstee, of the ‘Live more Awesome’ charity this weekend. The world’s longest slide will be open for only two days to raise funds and awareness of depression. (Photo by Phil Walter/Getty Images)

Commonwealth Bank, in line with many other forecasters, expect the Australian dollar will continue to slide in the period ahead – and by more than what they previously expected.

In a note today the bank’s currency and rates strategy team lowered their forecasts for the AUD/USD exchange rate in the year ahead, citing five key reasons why they believe it has even further to fall.

  • An extended period of below-trend GDP growth in Australia’s economy
  • A downward revision to 2015 global economic growth by the IMF
  • Continued downward pressure on Australia’s terms of trade
  • Narrower Australia-US interest rate differentials and
  • The USD is set to remain firm and further strengthen

Here’s their view on the likelihood for a prolonged period of below-trend economic growth.

“The downturn in Australia’s mining investment sector will accelerate towards the end of the year. While Australia’s real GDP growth should not be too challenged as non-mining business investment, net exports and household consumption offset the slower growth in mining investment, there will be upward pressure on Australia’s unemployment rate because these offsetting areas of GDP growth are likely to be less labour intensive”.

And they see continued pressure on Australia’s terms of trade.

“Increased commodity supply (reflecting the fruits of the mining investment boom) and slower demand from China due to the cyclical downward in China’s property sector and wider economy, continue to put downward pressure on Australia’s key commodity export prices. Australia’s terms of trade is therefore set to remain under downward pressure, lowering real gross domestic income growth, and guiding the AUD lower. Australia’s terms of trade remains one of the best long-run guides to the AUD”.

Despite recent disappointing US economic data, including June retail sales overnight, CBA still believes the US Federal Reserve is likely to increase interest rates this year. This is at a time when the RBA is expected to keep interest rates on hold for the foreseeable future.

They also note that “historically, whenever the Australia-US two-year bond spread falls below 150bpts, it tends to put downward pressure on the AUD/USD”.

Essentially, with the Federal Reserve likely to tighten monetary policy in the period ahead while the RBA remains on hold, the narrowing gap between the interest rates of the two nations will put pressure on the Australian dollar. This chart shows the relationship:

CBA forecasts that by the end of 2015 the AUD/USD exchange rate will fall to 72c before sliding to 70c by the end of March 2016. These are lower than previous forecasts released in March of 76c and 75c respectively.

The AUD/USD currently sits at .7363, the lowest level seen since May 2009.

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