FYI | Mar 13 2008
By Chris Shaw
The Australian dollar is currently trading at around 93.7c against the US dollar with gains in recent months being driven by a combination of continued strength in the domestic economy, which has prompted the Reserve Bank of Australia (RBA) to lift interest rates, and further signs of weakness in the US economy.
While seeing continued strength in the Aussie dollar as likely in the short-term, as the US Federal Reserve continues its program of rate cuts, CIBC sees the medium-term outlook as significantly different and does not rule out the chance of a material correction in the Aussie dollar that could see it hit levels of US82-85c by the end of the year.
The group’s view is based on what it sees as the policy problems the RBA faces as it tries to deal with inflationary pressures at the same time as the latest data suggests the economy is weakening. Consumer sentiment in March fell to a 14-year low as measured by the Westpac-Melbourne Institute Index and CIBC notes in the past three months the index has fallen 21.2%, its sharpest quarterly fall since the index began in 1975.
Despite this the TD Securities-Melbourne Institute date shows inflation is currently running at around 4% compared to the RBA’s 2-3% target band, meaning there is little scope for the RBA to lower rates in the short-term even though the signs are the recent increases in interest rates are now impacting on consumer and business sentiment as funding costs continue to move higher.
While the decline in consumer sentiment has the market all but eliminating the chance of any further rate hikes in coming months there is now some pricing-in of cuts looking forward to the next 12 months.
According to CIBC this means the interest rate differential that to date has supported the Australian dollar against the greenback is unlikely to move significantly further in the Aussie’s favour as the US rate cut cycle appears to be largely front-loaded, so if interest rates in Australia do begin to come down later this year the group sees the risk for the Australian currency as clearly and significantly to the downside.
