Australian Dollar weekly update 19/01/2010

[John From Moneycorp]

BROAD IMPROVEMENT FOR STERLING

 

MPC member sets the ball rolling with talk of higher UK interest rates. Commodity currencies hit by tighter monetary policy in China.

 

After a day's hesitation in the vicinity of Monday's $1.73 starting point the pound set off higher. It made back two thirds of the previous week's losses to open in London this morning at $1.77.

 

Sterling had a good week on almost every front. On the rare occasions it failed to make progress - and only the yen springs to mind - it was steady. There was not universal support in every case to start with but by Tuesday there was wind in every one of sterling's sails. The pound owed its uncharacteristic advance to the Bank of England, specifically to Andrew Sentance, a member of the Monetary Policy Committee. He told The Guardian newspaper that 'Threadneedle Street has done enough to lift Britain out of its deepest post-war slump and will need to consider raising interest rates this year if a recovering economy poses a threat to inflation.' In his opinion the sixth consecutive quarter of falling output in the third quarter of 2009 presented 'an excessively downbeat' picture of the UK economy and he downplayed the risk of a double-dip recession.

 

That argument received corroboration the following day. The National Institute for Economic and Social Research ('Britain's longest established independent economic research institute' according to its own blurb) reckons the economy grew by +0.3% in the fourth quarter, contracting by -4.8% in calendar 2009. That last figure was given added punch by simultaneous news that Germany's economy shrank by -5.0% on the year. Although the NIESR is not responsible for the 'official' figures investors were happy to accept that the UK economy had finally returned to growth and they clung to that upbeat mood for the rest of the week.

 

The week's highlight for the Australian dollar came on Thursday when it picked up a quick cent on the back of another strong employment report. Australia added a net 35.2k new jobs in December after an upwardly-revised 32.4k in November. The unemployment rate went down by a tick to 5.5%. But it was not the economic data or any domestic news that most affected the Aussie last week. On Tuesday the People's Bank of China - the central bank - announced that it was increasing the amount of reserves that commercial banks would have to post with it. This tightening of monetary policy was apparently aimed at dampening a surge in domestic bank lending. Investors feared it would also put a brake on economic activity, not just in China but also in the rest of the world. All the commodity and emerging market currencies were hurt by the news, including the Australian dollar.

 

Sterling is off its 25-year lows but only by less than a handful of cents. As much as the AUD's rally looks overdone, to assume a reversal at this stage would be optimistic. Although it is likely the pound will be above its current level in six months' time that will be of no consequence to anyone with Aussie dollars to buy in the meantime. Buyers of the Australian dollar should hedge 50% of their requirement and be ready to cover the balance if the pound embarks on another advance to the rear.

[Guest stevieb]

I presume that as it's predicted the Reserve Bank will push up interest rates in Feb & March due to the prospect of rising inflation, that this will further strengthen the Aussie $. If that's the case, how low would you expect the £ to fall?

[John From Moneycorp]

Thanks for your message.

As you say, with interest rates likely to be raised in Australia, this should strengthen the Australian Dollar. In relation to GBP/AUD, this could see the low levels, from last October, of 1.72/1.73 being hit.

However, from a Sterling perspective, there are some important factors which would affect how weak/strong it will be over the next 2-3 months. For example, if we officially come out of recession, this should provide some momentum. In line with this, Monetary Policy Committee decisions (and views) will also affect Sterling.