Currencies | May 03 2011
– NAB lifts Aussie dollar forecasts
– Potential for AUD to remain elevated shorter-term
– Medium-term view is a gradual fall against the greenback
By Chris Shaw
In mid-April, National Australia Bank (NAB) senior currency strategist John Kyriakopoulos suggested the Australian dollar was likely to trade in a range of 1.00 to 1.10 against the US dollar, with 1.05 not an overvalued level.
At current levels near 1.10 against the US dollar however, Kyriakopoulos suggests the Aussie dollar starts to look expensive when viewed on medium-term criteria such as Australia's terms of trade or the current account balance.
Despite the currency appearing expensive, Kyriakopoulos suggests the current strength may persist shorter-term. This reflects some cyclical factors, one being speculation the Reserve Bank of Australia (RBA) may consider a hike in interest rates (this hasn't happened today).
Given this view, Kyriakopoulos has lifted forecasts for the Aussie against the US dollar by around US4c. Forecasts now stand at US$1.08 for the end of June, US$1.05 for the end of September and US$1.02 at the end of the year.
Supporting the short-term increases, Kyriakopoulos notes the market is yet to fully price in a 25-basis point rate hike by the RBA by year's end, this despite NAB itself expecting two such hikes to bring the cash rate to 5.25%.
At current levels, Kyriakopoulos suggests the Australian dollar trade weighted index is broadly in line with the forecast yield differential between Australia and the US over the rest of the year. This implies the currency is slightly expensive, supporting the view the Aussie dollar won't remain above US$1.10 over the next six months or so.
Given Australia's current account deficit has fallen sharply in recent years, Kyriakopoulos suggests the Aussie dollar isn't overvalued to the extent suggested by purchasing power parity analysis. If this was the case, Australia would soon be running consistent trade deficits, so widening the current account deficit.
To justify the current exchange rate Kyriakopoulos suggests the current account deficit would need to average less than 1% of GDP in coming years. Given IMF forecasts are for a current account deficit of closer to 3% over the next five years, Kyriakopoulos sees this as more consistent with an exchange rate of US$0.90-$1.00 rather than US$1.10-$1.20.
There is no change to Kyriakopoulos's expectations the Australian dollar gradually falls against the greenback, this due to a moderation in commodity prices, a peaking in Aussie interest rates and the start of a US rate hiking cycle.
On a medium-term view, Kyriakopoulos continues to suggest the average AUD/USD rate over the full cycle is shifting to US$0.90 from US$0.70, which was the average for the 20 years after the floating of the Aussie dollar in 1983.
This reflects expectations Australia's terms-of-trade averages 50-60% above the long-term average over the next decade. Above US$1.10 Kyriakopoulos suggests cyclical drivers of the currency, such as interest rate differentials, would need to persist or even widen by more than currently expected to keep the currency above that level.
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