We have been structurally bullish on the Australian dollar for some time now given Australia’s success in containing its domestic Covid-19 outbreak and ability to reopen their economy much earlier than G10 peers, with the exception of New Zealand.
However, the recent deterioration in the near-term global economic outlook due to uneven vaccine distribution and the threat of new strains poses downside risks for both the Australian economic recovery and Aussie dollar. This comes at a time when uncertainty over the domestic recovery has diminished somewhat due to authorities’ success in containing smaller localised outbreaks, but persists in how households and businesses will react to the tapering of support measures in the coming months. Given these developments, the Reserve Bank of Australia was quick to look through the positive string of recent data and instead opted to highlight the level of uncertainty that remained around the path of the domestic economic recovery. In doing so, Governor Lowe outlined how monetary policy needed to remain supportive as the central bank extended its QE purchases by another A$100bn and signalled that it wouldn’t hike the cash rate until 2024 at the earliest. The dovish announcements were coupled with explicit reference to the recent strength of the Australian dollar as the RBA’s statement noted “the exchange rate has appreciated and is in the upper end of the range of recent years” while also stating that the current monetary policy setting is “contributing to a lower exchange rate than otherwise”. The comments by the RBA pushed back market expectations of policy normalisation and has resulted in the Australian dollar becoming much more susceptible to a downturn in market risk appetite, where previously it had traded defensively with NZD against the US dollar in this scenario due to growth outperformance relative to G10 peers.
Given this, while we remain structurally bullish on the Australian dollar, largely due to positive growth differentials, headwinds from the RBA are likely to persist over the coming twelve-months as loose monetary policy continues to aid the economic recovery.
This not only leads us to believe that the rally in the Australian dollar will occur at a slower pace than that seen in Q4 2020, but also that the risks around this view are balanced as opposed to tilted to the upside.
Monex Europe’s AUD forecasts
DOMESTIC ECONOMIC REBOUND REMAINS STRONG, DRIVEN BY FIRMING LABOUR MARKET, WHILE LACK OF VACCINE DISTRIBUTION DOESN’T POSE A DRAG
Australia’s ability to control the domestic Covid-19 outbreak has paid dividends for the economy thus far, limiting the economic damage inflicted in 2020. The RBA now predicts that the full-year 2020 hit to GDP amounts to around 2%. This is a marked upgrade from previous estimates and outlines a higher base for the Australian economic recovery heading into 2021 compared to most other G10 economies. The latest 2020 growth upgrade is due to a positive string of economic data in Q4 as the economy managed to remain open overall with limited localised lockdown measures implemented in some provinces. Notably, the strength of the economic rebound has been due to the recovery in household consumption. Compared to business investment, which remains sluggish, consumption levels recovered some 8% in Q3, while soft survey data suggests household expenditure remained resilient in Q4 and the early part of 2021 too. This was due to a combination of monetary and fiscal support measures along with the safe reopening of the Australian economy, which not only allowed greater household consumption to take place but also reduced precautionary spending behaviour. This is expected to persist into Q4 given the strength of the labour market recovery, which saw the unemployment rate fall to 6.6% in December.
Australia’s economic recovery is expected to outstrip most G10 peers in Q4 as the nation avoided national lockdown measures while its labour market experienced a strong rebound
The outlook remains constructive for the Australian economy from a domestic standpoint, as the early stages of the recovery doesn’t hinge on vaccine distribution and the tapering of lockdown measures like most G10 peers.
The RBA’s latest forecasts reflect this, with the central bank anticipating the economy will expand by 3.5% in both 2021 and 2022. While there isn’t a pressing need for mass immunisation from an economic standpoint, the limited restrictions on economic activity will pose headwinds to the recovery further down the line. Given this, Australia is still pushing forward with plans to rollout Covid-19 vaccinations from late February, conditional on the delivery of 10m Pfizer vaccines. However, its economic prospects don’t hang in the balance as dramatically as other peers due to the effective elimination-type strategy currently in place.
The plans for Australia’s vaccination programme include more than 1,000 vaccination administration sites with an initial target of 80,000 vaccinations administered a week. The government aims to have administered 4m people by the end of March and half of the adult population by the middle of the year.
Australia will follow a staged vaccination programme as follows:
- Phase 1a – Quarantine and border workers, frontline healthcare workers, aged care and disability staff and residents: up to 1.4m doses.
- Phase 1b – Over 70s, other healthcare workers, aboriginal and islander people > 55, those with underlying health conditions and critical/ high-risk workers: up to 4.8m doses.
- Phase 2a: Adults aged 60-69, adults aged 50-59, aboriginal and islander people aged 18-54, other high risk and critical workers: up to 15.8m doses.
- Phase 2b: Balance of adult population: up to 16m doses.
- Phase 3: Under 18 if recommended: up to 13.6m doses.
DESPITE THE ROBUST RECOVERY THUS FAR, THE RBA IS SET TO KEEP POLICY LOOSE, POINTING TOWARDS LIFTOFF IN THE CASH RATE IN 2024
Despite the robustness of the economic recovery thus far, uncertainty around the RBA’s projections remains elevated despite diminishing somewhat since summer. Authorities’ ability to contain domestic flare-ups, like that seen recently in Perth and Victoria, was the main rationale behind more optimistic and less uncertain forecasts from the central bank, which now suggest the economy will return to end-2019 levels by the middle of this year. However, this wasn’t enough for the RBA to pivot away from its dovish stance as it opted to highlight the level of uncertainty that now centers on how the economy reacts to the tapering of economic support policies. This is especially the case with regards to the labour market.
Progress in the labour market has been sharp in Q4, but the recent decline in the unemployment rate was due to the loosening of lockdown measures in the state of Victoria as opposed to a broad-based and structural improvement. With the government’s flagship A$86bn JobKeeper Scheme set to expire at the end of March, which pays employers to keep workers on their books, progress in the labour market recovery is set to slow, or potentially even reverse. The RBA expects the unemployment rate to decline from 6.6% in December to 6% by end-2021, with further progress expected towards an unemployment rate of 5.25% in mid-2023. This conservative assessment of the labour market’s recovery towards the Bank’s 5% estimate of full employment gave Governor Lowe the impetus to strike a dovish tone in February’s meeting as the Bank stated liftoff in rates isn’t expected until 2024 “at the earliest”.
RBA February forecasts see GDP growth upgraded in the short-run but inflation below the 2-3% target over the forecast horizon
Throughout the RBA’s communications, this dovish tone was reiterated as it aimed to offset expectations of policy normalisation occurring earlier than other G10 central banks.
Governor Lowe was assertive in stating that loose policy is imperative to deliver the projected economic recovery as the RBA announced another A$100bn worth of bonds would be purchased under the QE programme. The expansion in the QE programme occurred earlier than many analysts expected, with space in the previous programme set to remain until April’s meeting. The earlier announcement highlighted how proactive the RBA wishes to be with batting away expectations of policy normalisation, which could cap further gains in AUDUSD over the coming 12-months. This has resulted in AUDNZD recently taking a leg lower due to monetary policy divergence.*November’s forecasts are included in parenthesis ()
RBA’s dovish forward guidance on policy normalisation keeps front-end AGB curve well anchored despite improvement in recent data points
RISKS TO THE AUSSIE DOLLAR NOW BALANCED AS OPPOSED TO TILTED TO THE UPSIDE
Previously, the risks to our AUD forecasts were tilted to the upside. We forecasted that the Aussie dollar, along with its New Zealand counterpart, would benefit from an economic dividend, with risks titled to the upside due to a faster economic rebound domestically being coupled with an improvement in overall market risk sentiment. Additionally, the RBA’s reluctance to enter into negative rates and the competency of containing domestic flare-ups meant that downside risks to this view were muted. However, since then, uncertainty around how the economy would react to the tapering of stimulus measures, the sluggish distribution of vaccines globally, and the RBA’s reluctance to discuss monetary normalisation in the near-term has increased downside risks to our bullish AUD call. On net, we now deem the risks to our bullish forecasts as balanced, especially in the short-term in the current environment of sustained USD support.
Author: Simon Harvey, FX Market Analyst