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Outlook for the Australian Dollar
Following sharp losses in August 2007 - when the US subprime crisis first came to light - we've seen the Australian Dollar (AUD) rally sharply once again – this time to 23-year highs of above US90c.
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- Outlook for the Australian Dollar -
Following sharp losses in August 2007 - when the US subprime crisis first came to light - we’ve seen the Australian Dollar (AUD) rally sharply once again – this time to 23-year highs of above US90c.
Behind this strength have been a number of ‘AUD boosting’ factors. The ‘carry-trade’ (money borrowed in low interest rate currencies such as the Yen and invested at higher interest rates in Australia and New Zealand) is back in vogue. At the same time, a range of domestic economic indicators have shown strength, leading the Reserve Bank to raise interest rates in both August and November. Meanwhile, overseas, strong commodity prices and a weak US dollar (USD) have also boosted the AUD.
Our concern, however, is that investors have been perhaps too eager to ride the rally, with the AUD now in overbought territory and equally, the USD oversold. Indeed, since early November, we appear to have entered a ‘2nd wave’ of the subprime crisis in which a number of major global banks have revealed the full extent of their subprime related losses. Once again, this has prompted increased risk aversion and a pullback in the AUD.
Even after these falls, at current levels of around US90c, we retain the view that the AUD is overvalued. Factors which we believe could see the AUD weaken further in the months ahead include a moderation in the pace of global growth (with the International Monetary Fund recently revising down their global growth forecasts for 2008 and noting that the risks are to the downside). A lower rate of global growth, in turn, has the potential to impact commodity prices and the AUD.
Meanwhile locally, we may see some reassessment regarding the need for further increases in domestic interest rates, which could impact the enthusiasm for carry trades.
Finally, we remain concerned about Australia’s continuing trade and current account deficits which are adding to the nation’s foreign debt.
Overall, we anticipate the AUD easing to the mid US80c range by the end of this year and possibly move below US80c in 2008.
Prepared by Steven Milch, Head of Economic Research, St.George Bank
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