The Australian dollar's recent downside move has been a lot stronger than we and the markets have been expecting - and the next potential catalyst for a further extension comes on Tuesday the 17th when the RBA's minutes to their most recent meeting are released.
- Pound to Australian dollar exchange rate at 1.9711 at start of new week
- Australian to US dollar exchange rate at 0.7286
- Euro to Australian dollar at 1.5524
- Australian to New Zealand dollar at 1.0754
The GBP to AUD exchange rate's powerful rally off of the 1.8287 lows, up to the recent 1.9806 highs, now leaves the pair looking overbought and in danger of a correction lower.
The speed of this rally alone is evidence that it will probably extend and could be the start of a new medium to long-term up-trend.
The break above the 1.9615 March highs, in particular, is a strong sign that this could be the start of a broader up-trend, and not just a correction.
However, despite this, the RSI indicator in the bottom pane is at 72, which means the pair is overbought, and probably due a correction in the short-term.
The RSI is a momentum indicator, and when it moves above 70 then it indicates the asset is overbought and investors are urged not to open any more long positions.
Traders open 'long' positions when they want to profit from the asset going up.
This does not mean the pair is about to reverse trend and start moving down in a strong downtrend, just that it may be due either a correction of a period of sideways consolidation before it goes any higher.
In this case we see this as likely to resolve itself as a pull-back to a strong support level like the R1 monthly pivot at 1.9555, followed by a resumption of the up-trend back up to the 1.9885 level.
We have been warning the GBP/AUD has been overbought since the 9th of May, the correction lower has still not taken place confirming how difficult calling such a move really is.
That said, it would be foolish to believe it won't come, as nothing ever moves in a straight line.
More Pressure on the AUD
The Australian Dollar has had a soft month and is expected to weaken further in the medium term, and probably next week too, as several fundamentals combine to undermine its outlook.
The first of these is that the price of one of Australia’s main exports Iron Ore has collapsed. It fell over 10% in the previous week. It is unlikely to recoup these losses either as its price was overinflated by short-term speculative buying rather than real demand.
This is likely to weigh on the Aussie for several reasons, the principle of which is simply that a lower price means aggregate demand for Australian dollars, from buyers purchasing the ore, will fall.
A second reason is that the lower revenue earned will put pressure on inflation which increases the possibility the Reserve Bank of Australia (RBA) will lower interest rates again it already lowered then in May to 1.75% from 2.0%.
Inflation is already under pressure, after recent data showed it fall to 1.3% in March from 1.7% forecast and 1.7% previous.
Now there is a strong chance that inflation will fall even more deeply prompting the RBA to lower rates again as it tries to push inflation back up to its 2.0% target.
Interest rate cuts weaken a currency because foreign investors are less likely to store their money in the country due to the lower return because of the poorer rate of interest.
Watch RBA Minutes
On Tuesday the 17th the RBA's minutes to the May meeting will be released and markets will be keenly anticipating evidence of a second 2016 rate cut.
Historically the Bank tends to follow one cut with another therefore we would not expect too much of a negative impact on AUD should this be the case.
Therefore, the risks are to the upside should the tone of the minutes be less aggressive than forecast.
Sterling Driven by Risk, Referendum Issues
In relation to the pound, GBP/AUD's value continues to be driven predominantly be the risk of the UK leaving the EU. The number of people saying they want to stay has increased from a week ago, but more have also said they want to leave too.
The average poll result according to the Financial Times poll tracker is showing ‘stay’ in the lead at 46% with ‘leave’ at 43%.
Most large bookmakers are saying there is a 75% probability of a the referendum returning a win for Remain, or 1/3, whilst the chances of leaving they estimate at between 25-30%.
The outlook for central bank policy is also now a factor increasingly affecting the pound.
Thursday’s Bank of England Quarterly Inflation report downgraded growth expectations but - interestingly - upgraded inflation forecasts for 2 years ahead, and there is a possibility investors are underestimating the chances of the BOE raising interest rates earlier than expected (assuming a referendum win for ‘Remain’).
Capital Economics’s Vicky Edwards read this as a “message to the markets” that the Bank of England was closer to hiking rates than previously. If this suggestion takes root and starts to shape expectations of an early interest rate rise, the pound could gain in the week ahead.
Data Hotspots in the Coming Week
Key data for the Aussie will be employment and wage data. It starts with the wage price index on Tuesday 17 and then on the following day the Unemployment Rate is released and expected to see a rise to 5.8% in April.
Employment Change is expected to show a 12.5k increase in jobs. If the figures are worse than expected they will sink the aussie further as they will weigh on the already pessimistic mood.
The other main release for the Aussie is the RBA meeting minutes out on Tuesday, which will be scrutinized for signs of how close members may be to making another rate cut.
The week starts with UK April inflation data on Tuesday, with analysts forecasting no-change from the 0.5% previous reading. A rise would support sterling whilst a fall weaken it.
March Average Earnings (plus Bonus) are out on Wednesday May 18, and are expected to moderate to 1.6% from 1.8% previously.
Again a rise would support the pound and vice versa for a drop.
April Retail Sales are forecast to rise 0.6% mom on Thursday. Whilst less significant it will help economist model expected Q2 growth.