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Where next for the Australian dollar?

Where next for the Australian dollar?

The Australian dollar has rallied 9% to its highest level this year in defiance of forecasts that were predicting it would weaken.

On Monday, the local currency was holding above US74 cents, having gained on Friday to trade around US74.39 cents, a level not seen since July 2015.

It’s up 9% from its January low when it was heading toward US68 cents.

The US dollar (USD) weakened across the board after data released on Friday showed that US wages unexpectedly decreased by 0.1% in January.

That was in spite of a better than expected increase in non-farm payrolls.

Data in the spotlight

“In our view, the decrease in wages is more [a] statistical blip than a sign the US labour market is turning down,” Commonwealth Bank’s director of FX strategy, Joseph Capurso said in a note.

“Nevertheless, we expect the FOMC [Federal Open Market Committee] to leave the [US Federal Reserve] Funds rate on hold next week."

With few US events scheduled this week, the USD is likely to be influenced by commodity and share markets in addition to the European Central Bank policy meeting, Capurso said.

"If the reaction to the ECB meeting pushes EUR lower as we expect, USD will lift, though we expect the USD to remain well below its cyclical high this week.”

What about talk of a Brexit?

The Australian dollar is at its highest level against the British pound since May 2015. It has traded above 52 pence compared with 48.81 pence on January 25 and around 45.45 pence in August last year.

Following months of negotiations, the UK Prime Minister David Cameron reached a deal with the European Union (EU) council at the recent EU Leaders Summit aimed at keeping the UK within the common bloc.

Now a formal domestic campaign is underway. The pound tumbled in February as London mayor Boris Johnson gave his support to the "Brexit" campaign which supports Britain leaving the EU. 

The UK will hold a referendum on June 23 this year on its EU membership.

“Overall, the moderation in UK growth momentum and political risks should keep the market flirting with the idea of a potential BoE [Bank of England] rate cut later in 2016. This will keep GBP rallies limited and AUD/GBP well supported in our view,” Capurso said.

The Australian dollar remains at its highest level this year against the euro.

"The lift in EUR/USD ahead of Thursday’s ECB policy meeting makes it vulnerable to a greater fall if the ECB 'over-delivers' as we expect," said Capurso.

He predicts the reaction of the AUD/EUR will not be as sharp given the recent gains in this exchange rate have priced in good news from China where the National People's Congress (NPC) is currently underway. 

The NPC started on Saturday and continues until March 15. So far announcements have confirmed China’s gross domestic product (GDP) growth target for 2016 has been cut from 7% to a range of 6.5-7.0%.

The risk of a hard-landing in Chinese economic activity appears further reduced after policymakers in China announced they aim to pursue more expansionary fiscal and monetary policies in 2016. 

RBA calm about currency

On March 1 after the latest cash rate announcement, commentary from the Reserve Bank governor Glenn Stevens suggested the RBA was not worried about the recent lift in the Australian dollar.

Throughout 2015, the strength of the Australian dollar was regularly mentioned in the monthly policy statements by the RBA, with a level around US65 cents targeted.

Commonwealth Bank currency analysts at the beginning of 2016 forecast the Australian dollar to drop to US65 cents by the end of March before recovery towards US70 cents by the end of the year.