These 2 factors could drive the Aussie dollar back towards US70c

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The Aussie dollar is up and about, but not all analysts think its recent strength will last.

The AUD closed the week at US79.15 cents, a gain of around 10% since the start of the year.

The Aussie made a concerted push towards towards US80c this week after the release of the RBA’s board minutes on Tuesday, but took a breather on Friday after RBA deputy governor Guy Debelle poured some cold water on the rally during a speech in Adelaide.

Although the Aussie has now gained around 10% for the year against the greenback, economist Paul Dales from Capital Economics argues that the gains won’t last.

Dales is sticking to his forecast that market forces will drive the AUD back towards US70c.

He predicts that the RBA will keep rates on hold, and that the favourable backdrop from a recent rally in commodity prices is unlikely to hold up in the second half of the year.

“In our view, the economy has improved, but it’s too soon to conclude that the battle against slow growth and low inflation has been won,” Dales said.

Dales noted that a recent run of strong economic data has contributed to the Aussie’s recent strength.

Simultaneously, a combination of weaker US data and political turmoil in Washington has pushed the US dollar index below 94 for the first time since April 2016.

That’s also pushed back the market’s expectations for an interest rate rise in the US, while the forecast timing for an increase in Australia’s cash rate has come forward:

Despite that, Dales cited Debelle’s speech today as evidence that the RBA is in no rush to hike rates.

Specifically, he referred to Debelle’s statement that the market shouldn’t read too much into the discussion in Tuesday’s minutes around a neutral cash rate of 3.5%.

The neutral rate is the theoretical cash rate at which monetary policy would have neither a tightening or expansionary effect on the economy.

“As such, we doubt the RBA will raise rates before 2019,” Dales said.

“We also expect that over the next 18 months, the US Fed will hike rates more than the market expects.”

Dales also noted the rally in iron ore prices, which have contributed to the Aussie dollar’s recent strength.

Benchmark 62% fines have increased from a low of $US53/t, briefly topping $US70 this week before closing at around $US68/t on the back of increased demand for steel in China.

Dales argues that the recent strength in iron ore prices won’t last, citing the recent slowdown in Chinese credit growth as a signal that the country’s economic growth is poised to decline.

“A drop back in the iron ore price to around $US50/t by the end of the year should weaken the Aussie dollar,” Dales said.

Dales argues that the combined effects of the RBA keeping interest rates unchanged through 2018, together with a fall in iron ore prices, may be enough to send the Aussie dollar back towards US70 cents.

“As long as such a fall isn’t driven by renewed deterioration in the economic outlook, then it should be considered a good thing,” he said.

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