- AUD forecasts cut at ABN Amro given downbeat RBA outlook.

- RBA to hold rates until next year but will hike twice in 2019.

- AUD to bottom out in third quarter, before recovering steadily.

© Taras Vyshnya, Adobe Stock

The Australian Dollar rose Wednesday as markets responded to a better-than-expected set of retail sales figures for May, although the data do little to alter a deteriorating outlook for Reserve Bank of Australia monetary policy, which prompted ABN Amro analysts to downgrade forecasts for the Aussie this week.

Australian retail sales rose by 0.4% in May, down only a fraction from the upwardly-revised 0.5% growth seen in April, when economists had forecast growth in consumer spending would dip to 0.3% for the month.

Separately, Australia's trade balance recorded its sixth consecutive surplus in May.

The Aussie was higher against all developed world currencies other than the Pound and New Zealand Dollar Wednesday. The data helped the Australian Dollar higher Wednesday with AUD/USD at 0.7387, while the Pound-to-Australian Dollar rate was up 0.08% at 1.7894.

Above: AUD/USD rate shown at hourly intervals.

Above: Pound-to-Australian-Dollar rate shown at hourly intervals.

While the data show Australian households still have appetite for retail spending and that the so called trade war between the US and China, which is Australia's largest trading partner, has not so-far had an impact on the trade-dependent Aussie economy, Wednesday's figures do little to improve the outlook for domestic inflation.

With inflation now expected to reach only the lower bound of the RBA's 2% to 3% target in 2018, expectations for rising Australian interest rates continue to pare back, leading analysts at ABN Amro to cut their Australian Dollar forecasts on Tuesday.

The Australian Dollar has long enjoyed support owing to Australia's high interest rates relative to the rest of the world. But, with global central banks raising rates this benefit has faded, and alongside it investor demand for Aussie Dollars.

"The Reserve Bank of Australia is in no hurry to tighten monetary policy, especially in the current environment, with fears of a looming trade war between the US and China. We therefore no longer think it is likely the RBA will hike interest rates in 2018, and now expect policy to remain on hold this year. We maintain our forecast for two 25bp rate hikes in 2019," says Georgette Boele, a senior FX strategist at ABN Amro.

RBA monetary policy is important for the Australian Dollar outlook because changes in interest rates are the raison d'être for most moves in exchange rates. Changes in rates, or hints of them being in the cards, are only made in response to changes in inflation but impact currencies because of the push and pull influence they have on capital flows and their allure for short-term speculators.

The RBA has now held its rate at a record low of 1.5% for nearly two years, citing below-target inflation and a debt laden household sector that it says is ill-equipped to handle the pressures of higher borrowing costs following years of weak wage growth. Aussie inflation has been below the 2% to 3% target for most of the time since late 2012.

Australian inflation has been forecast to rise back to 2% on two separate occassion so far in 2018 but each time the consumer price index has left analysts and economists disappointed.

"Financial markets have lowered their expectations for rate hikes by the Reserve Bank of Australia rate for the coming 18 months. As a result, the Australian dollar has struggled," says Boele. "We expect the Australian dollar to stabilise in the near-term and recover later in the year for the following reasons."

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Get up to 5% more foreign exchange by using a specialist provider to get closer to the real market rate and avoid the gaping spreads charged by your bank when providing currency. Learn more hereThe deterioration in expectations for Aussie rates has taken place at a time when the US Federal Reserve and other central banks are making progress in raising their interest rates or otherwise jettisoning their post-crisis policy programmes.

This has had a severe impact on the Australian Dollar, which has long enjoyed support from interest rates that were for-a long-time higher than those elsewhere in the developed world. The AUD/USD rate is down mroe than 6% this year.

Boele and the ABN Amro team say that a likely bottoming out of iron ore prices and a steady performance from the Chinese economy can offer the Australian Dollar some support during the months ahead, and that a 2019 repricing of market expectations for Aussie interest rates will then do the heavy lifting once into the New Year.

Iron ore is Australia's largest single export, with almost all of it headed to China, although prices have been under pressure in 2018 adding to the Aussie's woes. Iron ore is down from over $70 per tonne at the end of 2017 to $63.65 Wednesday, but ABN Amro's metals analysts say the price has now bottomed.

Boele also says that recent weakness in the Chinese currency will be arrested by the People's Bank of China before long, which is seen providing assurance to markets in the context of the US-China trade tariff fight.

"Our base case scenario is that a significant escalation of the trade conflict is averted. In the near-term, tough, rhetoric will continue to weigh on EM FX and cyclical FX (such as the Australian dollar), but once the situation calms down somewhat, a considerable recovery of the Australian dollar is on the cards," Boele writes, in a briefing Wednesday.

Boele and the ABN Amro team forecast the Australian Dollar will fall to 0.72 against the US Dollar before the end of September, which is down from an earlier forecast of 0.75. However, the exchange rate is expected to recover to 0.74 by year-end and to 0.80 before the curtain closes on the 2019 year. They predict the Pound-to-Australian-Dollar rate will rise steadily from 1.79 Wednesday to 1.81 before year-end.

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Get up to 5% more foreign exchange by using a specialist provider to get closer to the real market rate and avoid the gaping spreads charged by your bank when providing currency. Learn more here