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Fundamental Forecast for Australian Dollar: Bearish

– RBA Governor Glenn Stevens remarks that interest rates are “pretty close” to normal

– Headline consumer inflation jumps to the top of the RBA’s tolerance band, but core figures softening

– AUDUSD fails to catalyze a channel break. Technical levels blocking progress in both directions

Someone once said that it was tough to be the king. That is the sentiment that the Australian dollar would have should it express emotion rather than respond to it. Indeed, it is difficult to be at the top of list because you are forever trying to maintain your position.

The Aussie currency quickly raised to its prominent position over the majors in the midst of the financial crisis after global interest rates bottomed out; because the worst for this particular unit was a short-lived economic slump and a benchmark that was still well above the crowd. Naturally, the subsequent recovery from this modest correction would encourage a quick return to expansion and a very early revival of interest rate hikes.

For some time, the Aussie dollar dominated the fundamental scene; but recently, its ascent has slowed and other currencies have begun to catch up.

 

The BoC is expected to hike rates at its next meeting and the RBNZ is predicted to move within the next two. As for growth, most of the G-7 has put in for a recovery (and some have even found a stable platform for growth – not just a stimulus born run). However, this slow catch up could preserve the Australian dollar’s advance for some time. On the other hand, a slip from within could quickly turn things around.

When defining the fundamental strength of the single currency; it is fair to say that robust growth is the rudder and interest rates are the sails. Growth is no longer so disparate that the Aussie dollar can maintain a significant advantage – at least not one by traders’ standards as they are more short-term focused. The real climb comes with yield. A quick comparison shows the benchmark lending rate in the island country is already 4.25 percent for a considerable premium over its counterparts.

However, the real impact is from expectations. Heading into this week’s rate decision, traders are haunted by Governor Glenn Steven’s remark not long ago that the current level of rates is “pretty close” to the normal that the group was targeting. Indeed, this past week’s inflation data showed price pressures are not yet out of line.

Looking at economists’ forecasts, there is a heavy majority behind another 25 basis point hike; but the market is less sure. Overnight index swaps (from Credit Suisse) show a much more indecisive 55 percent probability.

Should the central bank decide to hold rates, it would be considered a step towards a general shift in approach to policy that would lead to much more time between follow up hikes. If that is the case, it would open the door for other nations and currencies to catch up. This will likely prove so prominent a theme that it will likely overwhelm most trends in underlying risk appetite.

And, while we may be focusing on interest rates through the week, the rest of the calendar should not go overlooked. The docket is fully stocked with notable event risk. Before the central bank decision, proprietary inflation data will refine the argument of future price pressure. Aside from that, we will get a full view of economic activity. From the business sector, activity reports for the factory, service and construction sectors are all due. For the consumer, retail sales for March will round out the quarter. And, finally, the trade balance will offer a look at the ever vital Chinese export connection. – JK

For weekly forecasts for the US and Aussie Dollar, visit DailyFX.com.

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