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Australian dollar drops on cash rate debate

AUD drops on cash rate debate

The Australian dollar hit its lowest level since early March after the US dollar jumped sharply on reports that Federal Reserve officials felt the US economy could be ready for another interest rate increase in June.

Most participants in the policy setting committee's April 26-27 meeting said they wanted to see signs that economic growth was picking up in the second quarter and that employment and inflation were firming, according to the minutes.

"Then it likely would be appropriate for the committee to increase the target range for the federal funds rate in June," according to the Federal Open Market Committee (FOMC) minutes.

The suggestion that a rate increase in June is firmly on the table suggests the Fed is closer to tightening monetary policy again than Wall Street had expected. The Fed lifted rates in December for the first time in nearly a decade.

The greenback responded with a rally against most agri‑exporter currencies and the Australian dollar was no exception, Commonwealth Bank commodities analysts said in a note.

Aussie battler

The Aussie had quite a weak Wednesday ahead of the Fed minutes, falling to US72.29 cents.

"Nevertheless the Aussie had battled its way back up to almost US73 cents ahead of the greenback’s surge. The Aussie though fell three quarters of a cent when the surge came."

By mid-morning Thursday, the Aussie was trading at US72.18 cents, its lowest since the start of March this year.

"There has been a lot of interest in the recent slide of the Australian dollar," notes CommSec economist Savanth Sebastian. "The Aussie dollar was near US77.2 cents just over a fortnight ago, ahead of the Reserve Bank interest rate decision and given the surprising [cash] rate cut [to a record low 1.75%] and change in Reserve Bank inflation forecasts, the Aussie dollar fell."

"The question is where to for the currency from here? CBA currency strategists have released updated currency forecasts – lowering end-2016 forecasts from US78 cents to US73 cents," Sebastian said in a note.

Fed rate rise

Currency strategist at Commonwealth Bank Richard Grace said in a note: "We recently changed the timing of our next Fed interest rate increase from June to December.

"At this stage we will remain with the later Fed rate hike call, but the risks have clearly swung towards an earlier FOMC rate hike, which would give the USD further short-term strength because the interest rate market remains under-priced for a June rate increase. Current market pricing now shows the probability of a June Fed funds increase as 30% and, if that doesn’t occur, a December Fed funds increase at 75.3%." 

Grace said that fundamentally, there remains good support for the AUD.

"We don’t anticipate dramatically large declines in AUD/USD; the Australian economy is in good shape, global commodity prices (and Australia’s terms of trade) are recovering, Australia’s current account deficit is improving, and the USD should not get too strong."

This article is intended to provide general information of an educational nature only. It does not have regard to the financial situation or needs of any reader and must not be relied upon as financial product advice. Past performance is not a reliable indicator of future performance.