The Reserve Bank of Australia (RBA) looks set to cut interest rates aggressively over the next 18 months, but it’s unlikely to result in any meaningful decline in the level of the Australian dollar.
That’s the view of James McIntyre, an analyst at Macquarie Research who has been on the money of late when it comes to Australian interest rates. He believes that additional monetary policy easing from the Bank of Japan and Bank of England, among others, along with a less aggressive rate hike schedule from the US Federal Reserve, will keep the Aussie well supported in the year’s ahead.
“With a diminished outlook for monetary policy divergence the prospects for a lower A$ have weakened,” says McIntyre.
“We remain of the view that the RBA will need to cut rates further, dragged down by a disinflationary outlook. But with easing elsewhere, those rate cuts are unlikely to deliver significant A$ weakness. Rather, rate cuts are now likely to be needed to contain A$ upside. Although the RBA is cutting, we don’t think it will be cutting fast, or far, enough.”
As a result, McIntyre believes that it will be hard for the AUD/USD to break below the 70 US cent level, an area that the currency ventured below earlier this year.
“In the absence of a shock, we think that the hit to global growth and shift towards a less restrictive monetary policy stance is likely to support the A$. A firmer currency will dampen the inflation outlook, and also provide less impetus for economy’s rebalancing,” he says.
As shown in the chart below, supplied by Macquarie, the bank now expects the AUD/USD to bottom out at 72 cents in 2017, a far cry from the 65 cent level seen just two months ago.
Along with hindering Australia’s economic transition (Macquarie now sees GDP growth of 2% in 2017, down from 2.5% forecast previously), McIntyre believes that strength in the Aussie could help to boost migration levels, further exacerbating disinflationary pressures that already exist within the domestic economy.
“We see this as weighing further on the inflation outlook, as the economy will struggle to grow fast enough to keep up with potential, absorb spare capacity, and generate inflation,” he says.
In order to help counteract disinflationary forces, McIntyre believes that the RBA will have to cut rates lower, sooner and for longer than what many in financial markets currently believe.
“We retain our base case for a 25bp August rate and our forecast for a 1% cash rate trough,” he says. “We now expect the RBA will reach that low sooner, in 2Q17.”