Currencies | Nov 04 2010
By Chris Shaw
Given only a 26% probability had been attached to an increase in the cash rate at this week's meeting by economists, the decision by the Reserve Bank of Australia (RBA) to hike rates by 0.25% was a surprise for the market.
The dollar reacted by pushing through parity against the US dollar and in the view of Danske Bank further such hikes can be expected. This reflects both the terms of trade gains the Australian economy is enjoying from higher commodity prices, as well as some signs of reduced slack in the economy overall.
Danske Bank suggests the latter implies tighter monetary policies are warranted given a need to contain inflationary pressures and asset price bubbles.
In contrast to the tightening in monetary conditions in Australia, Danske Bank notes the US continues to ease monetary conditions by moving towards a second round of quantitative easing. With the US continuing to ease conditions, Danske Bank suggests Australia won't need to lift interest rates as much as otherwise would be the case.
Higher interest rates in Australia are still on the agenda in Danske's view, the bank forecasting the cash rate will hit 5.50% in 2011. So while the Australian dollar is currently very overvalued against the US dollar, by close to 40% on fair value models, the bank sees scope for further upside in coming quarters.
Danske Bank is forecasting an AUD/USD rate of 1.05 in six months. National Australia Bank also expects the Australian dollar will continue to trade above parity with the US dollar, similarly forecasting a rate of 1.05 against the US dollar in 2011.
As NAB's senior FX strategist John Kyriakopoulos notes, further quantitative easing in the US is likely to be a negative for the US dollar in general, as it isn't clear whether a lowering of US bond yields will help boost economic growth. As well, Kyriakopoulos sees scope for even more quantitative easing programs if the current program doesn't work in boosting US economic growth.
Adding in the fact this week's rate hike by the RBA has widened the Australia-US 2-year swap rate to 480 basis points and that commodity prices should remain elevated given an expected recovery in China, Kyriakopoulos expects the Australian dollar will remain well supported against the greenback.
Kyriakopoulos also takes the view the market is under-estimating the extent to which the RBA will lift interest rates in 2011, as in his view the RBA can't allow both a mining boom and a household spending boom at the same time. This he suggests is another reason to expect further upside in the Australian dollar against the US dollar.
