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A few weeks can seem a long time in the currency markets…

Published: Friday 09 November 2018

  • ​​See-sawing fortunes of GBPAUD
  • Change in policy for China’s economy
  • Could Brexit be nearing the endgame?
A few weeks can seem a long time when it comes to the international currency markets. The Australian Dollar, lifted by good news about its economy and that of top trade partner, China, strengthened against the Pound during the last month. Sterling, itself periodically boosted by optimism that a Brexit agreement is nearing, reached a high of 1.86960 in typical mid-market rates in early October, but sank to a low of 1.79000 at the end of the month, following worries over economic growth and spending revealed in the UK Autumn Budget. In early November, the pairing has stayed around 1.80-1.81.
See-sawing fortunes of GBPAUD

Optimism has surrounded both the Great British Pound and Australian Dollar over the last month, causing a seesawing of fortunes. In the second week of October, Sterling reached a monthly high against the Aussie Dollar of 1.86960, as the Bank of Australia sent out dovish signals that inflation was too weak to raise interest rates any time soon.

Fast forward a couple of weeks and GBPAUD fell to 1.79000, as optimism rose about the strength of the Australian economy, along with welcome signals from China that new stimulus is being planned to grow its economy. In its November 2018 statement, Reserve Bank of Australia left its cash rate unchanged at 1.5%, but indicated increased optimism. Governor, Philip Lowe, says the global economic expansion is continuing. “A number of advanced economies are growing at an above-trend rate and unemployment rates are low.”

Although growth in China has slowed a little, the authorities are easing policy, while continuing to pay close attention to the risks in the financial sector.  Globally, inflation remains low, although a further rise is expected given the tight labour markets and, in the United States, the sizeable fiscal stimulus.

There is also ongoing uncertainty regarding the effect of its international trade policy. But the Australian economy is performing well, with Gross Domestic Product (GDP) up 3.4% and unemployment falling to 5% – which is a six-year low – and is set to drop even further to 4.75% in the next year or two. As a result, the forecasts for economic growth in 2018 and 2019 have been revised up a little. Mr Lowe explains, “The central scenario is for GDP growth to average around 3.5% over these two years, before slowing in 2020 due to slower growth in exports of resources.

Business conditions are positive and higher levels of public infrastructure investment are also supporting the economy, although the level of household consumption is an ongoing concern. Australia's terms of trade have increased over the past couple of years and have been stronger than earlier expected. This has helped boost national income. While the terms of trade are expected to decline over time, they are likely to stay at a relatively high level. The Australian Dollar remains within the range that it has been in over the past two years on a trade-weighted basis, although it is currently in the lower part of that range.”

Inflation remains low and stable. Over the past year, CPI inflation was 1.9% and underlying inflation 1.75%, in line with bank expectations. “Inflation is expected to pick up over the next couple of years, with the pick-up likely to be gradual. The central scenario is for inflation to be 2.25% in 2019 and a bit higher in the following year.” This was in contrast to the reserve bank’s dovish October statement, which suggested that one-off declines in some prices during the September quarter were expected to result in inflation in 2018 being a little lower than expected. This weakened the Australian Dollar.
Australian dollar banknote money cash background - Halo Financial

Change in policy for China’s economy

It’s a different story for Australia’s close trading partner, China, where disappointing economic results and the effect of US trade tariffs are causing a change in policy. In the past, the Politburo has focused on controlling financial risk by lowering debt, alleviating poverty and combatting pollution. Yet, in early November, China announced it was to increase market reforms, due to the threat from the United States trade war. To date, the US has imposed tariffs worth $250 billion on Chinese goods and has threatened to add another $267 billion.

China, which is more limited in its actions, had imposed $110 billion tariffs on United States goods. The Politburo statement says there are worries over the “growing downward pressure” on the economy from a hostile international environment and that there are also “many difficulties with certain enterprises and the emergence of risks accumulated over long periods of time”. China needs to be more forward-looking. It must enhance reform and focus on core problems with targeted solutions, the statement goes on. “We must get our own things done and firmly seek high-quality growth.” The day after the statement was published, Chinese Vice-President Wang Qishan, adopted a more conciliatory approach. He told a Bloomberg New Economy forum,  "China will stay calm and sober-minded and embrace greater openness. Both China and the US would love to see greater trade and cooperation. We're ready to discuss and work for a solution on trade that is acceptable to both sides.” China is Australia’s biggest export market and the US/China trade war could cut $36 billion from the Australian economy over the next decade, estimates financial advisor, KPMG.
Could Brexit be nearing the endgame?

With just four months until Britain is set to leave the European Union, it looks like Brexit may at long last be reaching the end-game. Over the last few months, the Pound has been dragged up and down by rumours of success and failure in reaching an agreement with the European Union over the exact terms of the exit and relief at avoiding the uncertainty of a no-deal Brexit. UK Prime Minister, Theresa May, has survived the perils of the Tory conference and whispers of leadership challenges, and is reportedly confident of soon reaching a deal with Europe. However, she says this will “not be done at any cost" to the UK. The withdrawal deal is now reported to be 95% complete, but the problem of guaranteeing no new hard border in Ireland, is yet to be solved. Should that happen, and an acceptable deal is reached, then expect the Pound to get a boost, even if only temporary. The UK Budget in late October, announcing the end to austerity, brought a boost in spending and a change in growth forecasts, bringing the Pound to a monthly low against the Australian Dollar. UK growth in 2018 was forecast to be 0.2% lower than expected at 1.3%, due to impact of bad Spring weather. But the 2019 forecast was raised 0.3% to 1.6%, with 2020 and 2021 growth estimated at 1.4%, 2022 at 1.5% and 2023 at 1.6%, Chancellor Philip Hammond announced.
Guidance for AUD buyers

After topping out early October, GBPAUD corrected lower, aggressively falling back to 1.7860 within three weeks and the currency pair has been trading sideways since then.
The chart still looks quite bearish, so there’s a chance we’ll see a further move lower if the 1.7837 level gives way (50% of the whole move from 1.7273 low in Aug to the Oct high at 1.8740). If it does break lower, then expect a move down to 1.7620 (bottom of the current channel).
In the bigger picture, the good news is that GBPAUD still remains in a much longer uptrend (recovery from 1.55 low in Sept ’16) and of course, B-day approaches, so if a Brexit deal is agreed, I’d expect a rally in the Pound, probably 3-5% so 6-10 cents upside.
More immediately, without Brexit news, I’d suggest buyers target a move back up over 1.80, so place your limit orders 1.80-1.81 in the short term.

Guidance for AUD sellers
AUD sellers may consider selling here, but if you have a bit more risk appetite, you could consider targeting the 1.78 level.

GBP AUD chart November 2018

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