-AUD forecasts downgrade by Commonwealth Bank of Australia.

-AUD/USD still expected to rise through 2019, but at slower pace.

-GBP/AUD now eyes steeper fall that persists even after Brexit day.

© Neal Jennings, Reproduced under CC licensing

Australian Dollar forecasts have been downgraded by Commonwealth Bank of Australia in its latest review of currency markets, although the Antipodean is still expected to rise steadily against the US Dollar over coming quarters, and could go even further against Pound Sterling than previously thought.

The revised forecasts are good news for those already in Australia and seeking to finance trips offshore but will come as a blow for those in the UK, given the Pound is now staring down the barrel of a 5% depreciation against its Australian rival during the next 18 months.

"The modest AUD/GBP lift mainly reflects our expectation of protracted GBP weakness because of the UK's large current account deficit, negative interest rate differential and Brexit uncertainty," says Joseph Capurso, a senior currency strategist at Commonwealth Bank.

Capurso and the Commonwealth team say investors have few reasons to expect an appreciation of the Pound over coming months because uncertainty over the shape of the UK's future relationship with the European Union will continue to act as a headwind to economic growth. November is the earliest that clarity on the future relationship will come.

Meanwhile, the Bank of England is unlikely to provide much support to the Pound given that it has already raised interest rates twice inside the last nine months and is widely expected to sit on its hands until the Brexit question has been resolved. BoE forecasts suggest it wants to raise rates three more times in the next three years but this is contingent on a "smooth Brexit".

"If the UK leaves the EU with no withdrawal agreement or trade agreement, there is a rusk the BoE postpones its rate hiking cycle and the AUD/GBP will lift sharply as a result. Investors do not hold significant GBP short positions, meaning further GBP declines may manifest if the UK leaves the EU in a No Deal scenario," Capurso writes, in a note to clients Thursday.

Late November is seen as the last chance for negotiators from the UK and EU to agree the terms of the UK's withdrawal from the EU and the outline of the future relationship if the deal is to have any chance of being approved by the European Council and then ratified in all parliaments across the EU before the March 29, 2019 Brexit date.

Without an agreement, the UK will default to trading with the EU on World Trade Organization terms. There is widespread disagreement about exactly what this might mean for the economy in the short and longer term but most forecasters and pundits have acknowledged there will be at least some short term impact on economic growth.

Precedent set by almost all past negotiations involving the European Commission suggests the Brexit talks could go down to wire, with an agreement clinched only at the 11th hour, although it remains to be seen whether the Commission views the eleventh hour as being inside 2018 or some time in March 2019.

Capurso and the Commonwealth team forecast the Pound-to-Australian-Dollar rate will fall to a low of 1.70 before the end of March 2019, before rising back to only 1.71 in time for the end of 2019. This implies that a 5% depreciation is in the cards for the coming months. The Pound-to-Aussie rate was quoted 0.72% higher at 1.8104 Friday.

"We recently modestly reduced our AUD/USD forecasts," Capurso says. "Our new AUD/USD forecasts reflect a stronger USD, slower Chinese economic growth and weaker commodity prices, and a further delay to the start of the RBA rate tightening cycle. We now expect AUD/USD to more or less trade sideways in the remainder of 2018 before lifting slightly by the end of 2019."

The Australian Dollar itself has been buffeted repeatedly by a series of adverse events in 2018. Its woes began with a deterioration of the domestic inflation and interest rate outlook that has created an incentive for investors to sell the Antipodean and buy other currencies like the US Dollar instead.

But they culminated recently in a fall to a fresh two year low for the AUD/USD rate as investors dumped the risk-sensitive currency in favour of so-called safe-havens in response to an escalating trade conflict between the US and China, as well as bouts of financial instability in some emerging markets like Turkey and Argentina.

The Wall Street Journal reported Thursday that Japan could be President Donald Trump's next trade target, spooking markets including the Australian Dollar.

But most significant in recent months has been the loss of yield support for the Aussie, reflected in the now-negative gap between yields on Australian and US government bonds.

The Aussie had long enjoyed support from interest rates and bond yields that were typically higher than those elsewhere in the developed world, but the Reserve Bank of Australia has kept its interest rate at a record low of 1.5% for more than two years now while the Federal Reserve has raised its rate seven times, to the current 2% level, since the end of 2015.

The last time the Australian-US yield differential was as unfavourable for the Aussie as it is now, a short time after the new millennium, the AUD/USD rate was trading just north of the 0.50 level.

Capurso and the Commonwealth Bank team forecast the exchange rate will close the 2018 year at 0.72 before rising steadily to 0.75 by the end of 2019. The AUD/USD rate was quoted 0.60% lower at 0.7147 Friday.

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