The Australian Dollar is predicted to weaken over the next year-and-a-half as a fall in commodity prices, an under-employed work-force, high levels of debt and unprofitable banks weigh on the outlook.

These are the views of Morgan Stanley who have released a mid-year update concerning the outlook for AUD.

Australia’s main export is Iron Ore and prices are now higher than they were a year ago.

The prices of iron ore and coal, however, have declined over recent months, unwinding some of the earlier increases.

Morgan Stanley believe the outlook is not rosy for the commodity as its main market is China which is slowing down.

Not only are stockpiles still high after a restocking drive when prices were low in 2016, but the government is changing its broader economic strategy away from heavy industry to focus on increasing the services sector.

Regarding the labour market, looks can be deceptive says Morgan Stanley.

“Although unemployment recently ticked down, a more holistic view of the labour market paints a weaker picture, with underemployment and participation both showing weakness. At the same time, domestic inflationary pressures remain weak, in particular on the wage side,” said the bank’s chief analyst Hans Redeker.

Aussie Dollar to Lose Support of Superior Interest Rate

At its June policy meeting the Reserve Bank of Australia left its base borrowing rate unchanged at 1.50% which ranks second behind New Zealand’s 1.75% as tops among developed nations.

Base interest rates in Australia are still relatively high by G10 standards therefore but that advantage is expected to be eroded by other countries raising their interest rates.

The difference between interest rates is a key driver behind exchange rates as money tends to flow towards currencies with higher interest rates, all other things being equal, so AUD is likely to weaken if the RBA keeps rates unchanged but they rise elsewhere.

Morgan Stanley argue the negative economic outlook in Australia does not favour any further rate increases from the RBA – indeed if anything they should be thinking about lowering them to stimulate the economy.

The RBA is unlikely to lower rates, however, because of the ‘financial stability risk’ of doing so.

This basically means the risk from irresponsible lending and borrowing, which is reflected in the overheating housing market.

Fiscal Investment

The recent government budget contained infrastructure spending plans which normally would support a currency, however, in this case they did not because they are being paid for by increasing taxes on banks.

Banks are expected by Morgan Stanley to struggle under the burden of higher costs and this could lead them to restraint and/or passing the costs onto customers.

Forecasts

All said, Morgan Stanley are forecasting AUD/USD to fall to 0.64 by the end of 2018 after making a high of 0.75 this summer.