GBP/AUD to push lower as Australia's Economic growth booms
RBA decision Tue dominates the calendar, with about 35bp hike priced in. Limited data: Apr housing finance Fri, May MI inflation gauge and ANZ job ads Mon.
The Aussie has outperformed most of the G10 over the week, backed by resurgent energy prices and periods of improved risk appetite. The latter is to some degree attributable to China’s reduced Covid case numbers, which state media is touting but more tangible are looser activity restrictions in major cities.
But the tension remains between the benefits to Australia’s already strong trade position – see chart – from high energy and industrial commodity prices and the squeeze on business and consumers from the surge in oil and gas prices, given its implications for growth and equity sentiment.
Indeed the correlation between daily log returns in AUD/USD and MSCI Global is at the upper end of recent ranges, 0.77 over the past 30 days, 0.73 over 60 days. With this in mind, the fragile foundations of global equities leaves us skeptical of the sustainability of the Aussie’s probes above 0.7200.
If the RBA delivers the 40bp hike to 0.75% that we expect and remains upbeat on the growth outlook, A$ should be able to hold in the 0.7100 to low 0.7200 area but with ranges to move lower over June.
AUD against the GBP
AUD/GBP rallied steeply in the wake of Russia’s invasion of Ukraine on 24 February, from about 0.5350 to above 0.5800 in April and recently mostly around 0.5700.
The UK economy is clearly more exposed than Australia’s to the impact of the war. The BoE forecasts 0% ‘growth’ over the next year, given “the significant adverse impact of the sharp rises in global energy and tradable goods prices on most UK households’ real incomes and many UK companies’ profit margins.”
While the BoE started unwinding pandemic policy settings back in Dec 2021, UK inflation hit a staggering 9%yr in April. Markets price the bank rate to rise from 1% to 2.35% by year-end.
Australia in stark contrast is a massive net exporter of energy products, already running large trade surpluses (see p4). The RBA forecasts GDP growth of around 3% over the next year and inflation above 4% through mid-2023.
Markets are pricing in aggressive RBA tightening, to a cash rate near 2.8% by end-2022. The surge in AU yields has boosted its pickup versus GBP to multi-year highs – see across. This yield support should help AUD/GBP rally to 0.59 in Q3. Near term though, any substantial deterioration in risk appetite could pull the pair back to 0.5650/70.
The UK-specific factors appear to be mostly negative and not even the steps taken by the government to limit the economic hit was enough to improve GBP performance. The announcement of GBP 15bn of support for UK households will help to shelter households from the cost of living crisis and should improve the real GDP profile. The BoE currently forecasts GDP contraction in Q4 reflecting the hit to real incomes from the OFGEM cap increase, effective October, which has been estimated to be a 42% increase, or around GBP 800 per household. The support package gives all households GBP 400 and the 8mn poorer households an additional GBP 650 with other cash support through a universal credit uplift. The total support added to already announced measures equates to GBP 37bn or 1.5% of GDP. This should lift the GDP estimates for Q4 this year and the BoE 2023 GDP estimate of -0.25% will likely be raised also.
Previously we had assumed the BoE would hike twice further before pausing for the remainder of the year. The action from the government may encourage the BoE to deliver more and we have tweaked our view to show one additional 25bp rate hike in September before a pause in Q4. Beyond that the support package does not alter the outlook and indeed, the hit to households will still be felt given these are one-off payments and energy prices are likely to remain elevated in 2023. PM Johnson tenure as PM remains in question after the ‘partygate’ report from Sue Gray with calls for him to step down getting louder. There will also now be focus on increased tensions with the EU with the government planning to table legislation in parliament allowing for aspects of the Northern Ireland Protocol to be ignored. If this legislation passes in the coming weeks it will likely result in some form of retaliation by the EU that will elevate risks of a trade conflict in the second half of the year.
We still expect GBP to perform poorly. Weak growth (despite fiscal support), a BoE more cautious on tightening going forward and increased uncertainty related to trade with the EU will continue to weigh on the pound. Tighter financial conditions will also leave GBP vulnerable over the short-term.
We remain short GBPAUD with no targets in sight. If this trend persists, we could hit 1.63300 this year.
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