Australian Dollar Gains Strength as Analysts Predict Sustained High-Interest Rates

The Australian Dollar, along with its high-risk counterparts, the New Zealand Dollar and Norwegian Krone, experienced significant gains in anticipation of a more positive risk sentiment trend. Analysts at Commerzbank, a global lender and investment bank based in Germany, have conducted an analysis of the Australian economy’s underlying condition. Their findings suggest that the Reserve Bank of Australia (RBA) is likely to maintain elevated interest rates in the months ahead.

According to Michael Pfister, an FX Analyst at Commerzbank, “It is worth taking a second look at the data. In our view, the upside risks for the Aussie in the coming months are predominant.” Pfister’s assessment comes as the Australian Dollar-U.S. Dollar exchange rate rebounds from a 10-month low, marking a 1.0% increase to 0.6498, as the U.S. Dollar retraces recent gains. While the Australian Dollar faced pressure against the U.S. Dollar, it exhibited strength against the Pound, Euro, and other currencies, indicating emerging idiosyncratic strength.

The pound-to-Australian dollar exchange rate fell by 4.0% from its mid-August peak of 1.99 to 1.8872 as of the most recent update on September 29. In parallel, the Euro to Australian Dollar exchange rate experienced a nearly 3.0% decline, resting at 1.6334.

Pfister attributes the earlier poor performance of the Aussie Dollar in 2023 to “idiosyncratic factors.” He points out, “One factor was that the Reserve Bank of Australia (RBA) quite surprisingly left its interest rate unchanged again in early August after a pause in July. Since then, the market’s interest rate expectations have corrected significantly.” However, he notes that Australian rate expectations have recently strengthened, indicating a potential rate hike in early November. This analysis suggests that if Pfister’s predictions hold, the Australian Dollar could see gains in the coming weeks.

Despite these developments, monthly inflation figures have not yet aligned with the inflation target, raising concerns about the potential for the more comprehensive quarterly inflation figure, which the RBA relies on, to disappoint on the upside. Pfister observes, “The bottom line is that with inflation above 5%, the RBA is still a long way from its target.” The central bank’s particular concern is the elevated levels of Australia’s services inflation, potentially warranting another hike in November.

“As in other Western industrialized countries, the inflation driver in Australia has shifted from goods to services. And here the inflation trend is still clearly upward, even if the pace has slowed recently,” says Pfister. However, the focus for the Australian Dollar and other currencies at this juncture is not just the likelihood of rate hikes but the rate cut outlook for 2024 and beyond. Investors are likely to favor currencies where rate cuts are less likely to occur soon or be more drastic.

In this context, the Australian Dollar could find support if incoming inflation data reduces the prospects of Australian interest rate cuts. Pfister notes, “The RBA recently reaffirmed its forecast that inflation will return to the target corridor of 2-3% by the end of 2025 – i.e. within the forecast horizon. Nevertheless, given the long time horizon and the uncertainties described above, the bar for initial rate cuts is likely to be high.”

Additionally, Commerzbank considers Australia’s labor market as “tight,” resulting in low unemployment and high wages, which do not align with sustained declines in inflation to the RBA’s target. The strong trade ties between Australia and China, the world’s second-largest economy and primary export customer, are also a crucial factor to consider. Although China’s post-Covid rebound has been somewhat lackluster, Commerzbank sees signs of stabilization in China. Pfister asserts, “Further signs that China’s economic growth is stabilizing, albeit at a low level, should ease some of the depreciation pressure on the Aussie from this side.”

In summary, Commerzbank anticipates the RBA maintaining a “higher for longer” stance on interest rates due to the strength of the Australian economy. As a result, the Australian Dollar is expected to receive support in the coming months.