Australian Dollar Faces Rising Obstacles to Sustain Its Rally

(Bloomberg) -- The Australian dollar is in rally mode, but its further rise is unlikely to be smooth sailing.

It’s climbed to a 15-month high against the dollar due to a widening yield differential between Aussie bonds and U.S. Treasuries as the Reserve Bank of Australia dismissed the possibility of negative interest rates, while Governor Philip Lowe said that the currency was broadly in line with economic fundamentals.

However, this pillar of support for the currency may come under threat if inflation data this week prompts the RBA to shift to a dovish stance.

“With one eye on the currency, it is possible that Lowe will use the RBA meeting on August 4 to sound more dovish,” said Jane Foley, head of FX strategy at Rabobank in London. “We are cautious about these gains holding beyond the European summer,” she said.

Australia’s second-quarter consumer price inflation data is forecast to have fallen 0.5% year-over-year, well below the central bank’s target range of 2%-3%. New restrictions in Victoria and New South Wales, in response to the surge in coronavirus cases, threatens to further douse inflation, with estimates of a 0.75% reduction in national real GDP growth this quarter.

However, RBA isn’t the only factor behind the Aussie rally. An economic rebound in China, its biggest export market, and positive developments on a coronavirus vaccine have also helped the currency surge by about 16% against the greenback since April to be Asia Pacific’s best performer.

The dollar’s weakness due to an increase in U.S. virus cases and stimulus negotiations have also supported the Aussie’s recent rise to its highest since April 2019.

“The carry trade has been lifting AUD/USD and this could sustain in the near-term,” said Foley.

Still, risks remain with the Aussie growing vulnerable due to its deteriorating relations with Beijing and simmering tensions between U.S. and China. Foley expects the Aussie to fall to around 0.68/67 per dollar over the next three months.

Below are the key Asian economic data and events due this week:

• Monday, July 27: RBA’s Kent speaks, Japan all activity industry index and 1Q capital spending and company profits, BOJ summary of opinions, China industrial profits
• Tuesday, July 28: Australia weekly payrolls and wages, Japan PPI services, Malaysia trade balance
• Wednesday, July 29: Australia 2Q CPI, South Korea consumer confidence, Singapore 2Q unemployment rate
• Thursday, July 30: Australia building approvals, New Zealand business confidence and building permits, Japan retail sales, South Korea business surveys
• Friday, July 31: Australia 2Q PPI, New Zealand consumer confidence, Japan jobless rate and industrial production, China manufacturing and non-manufacturing PMI’s, South Korea industrial production, Thailand BoP current account balance

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