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- AUD rises on RBA optimism, U.S. tariff relief but for how long?

- Westpac, Morgan Stanley say sell the Aussie, buy GBP instead.

- NAB forecasts GBP/AUD rate decline.

The Australian Dollar extended a recent recovery against Sterling and other major currencies on Tuesday, September 18 as traders respond to an optimistic Reserve Bank of Australia (RBA) update while global markets breath a collective sigh of relief over the scope of the latest U.S. tariffs against China.

However, we find a good portion of the institutional analyst community are of the opinion the gains might be a short-term phenomenon.

The gains leave the Pound-to-Australian Dollar exchange rate down by 1.0% at 1.812, having earlier in the day hit a five-month best at 1.8399.

The Australian Dollar has certainly endured a volatile 24 hours.

The currency fell half a percent as the US government announced plans to apply tariffs on $200BN worth of Chinese imports, but then recovered half a percent on the view that the 10% tariff was a whole lot less damaging than the 25% initially expected.

Gains were cemented and then expanded by the release of the Reserve Bank of Australia minutes from its 4 September meeting.

The minutes proved positive for the Aussie Dollar as the RBA confirmed "the next move in the cash rate would more likely be an increase than a decrease".

There were concerns that rising funding costs - most famously evident through the increase in mortgage rates at Westpac - might see the RBA delay rate rises, or even cut rates.

Falling interest rates tend to hurt a currency as foreign investor capital is diverted to jurisdictions with greater returns.

In the event of the RBA news "yields on Australian government bonds increased by 3bps across the curve, supporting AUD despite the no change in guidance from the RBA," says Joseph Capurso with Commonwealth Bank of Australia.

Furthermore, the country's House Price Index revealed a quarter-on-quarter decline of 0.7% in the second quarter of 2018: this was good for the Aussie as markets had expected a more severe 7.0% slump.

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Aussie Relief at Latest Tariff Developments

Tariff wars are back.

However, the foreign exchange market reaction to the latest announcements appears to be more muted than in the past; for example the Dollar is hardly benefiting like we would expect while the likes of the Australian and New Zealand Dollars are actually outperforming.

The reaction suggests markets have had a good while to digest the latest moves by the US and China, therefore it is only new news that will really matter.

The Office of the U.S. Trade Representative said Tuesday it will levy a 10% tariff on goods imported from China that are worth around $200 billion annually from September 24, citing "unfair trading practices" that include the "theft of intellectual property and forced transfer of American technology".

Markets had been expecting a more punitive 25% duty.

"The latest developments clearly highlight the risk that trade tensions continue to escalate between the US and China. The financial market reaction overnight to the fresh tariff announcement has been relatively muted. The market appears to have taken the announcement in its stride so far, which may reflect in part that it was well anticipated," says Lee Hardman, a currency analyst at MUFG.

The shift to more protectionist US trade policies has aided in strengthening the US Dollar so far this year, especially against high beta commodity related and emerging market currencies.

"Yet, the announcement overnight has not proven sufficient to trigger renewed upward momentum for the US dollar. It is a further example of disappointing price action for the US dollar in recent weeks," Hardman adds.

President Trump has now imposed tariffs on Chinese exports worth $250 billion but Tuesday's tariffs are the most significant to date and mark a watershed moment in the so-called trade war between the world's two largest economies.

However, the market response was one of relief, likely due to the fact the tariff rate to be applied is just 10% when it could have been as high as 25%. China has been quick to retaliate previously but is yet to take action.

"We deeply regret this. In order to safeguard its legitimate rights and interests and the global free trade order, China will have to counter the system," says a spokesperson for China's Ministry of Commerce, in a statement.

The AUD/USD rate was quoted 0.76% higher at 0.72 during early trading Tuesday while the Pound-to-Australian-Dollar rate was 0.78% lower at 1.8254.

GBP/AUD to rise say Westpac, Morgan Stanley

As strong as they are, Tuesday's performance from the Australian Dollar may not last if analysts at Westpac and Morgan Stanley are right in their current thinking.

"The Aussie has fallen more than 4% against the British pound since late August on a combination of greater optimism over Brexit negotiations and AUD negatives such as US-China trade tensions and Australian political turmoil," says Sean Callow, an FX strategist at Westpac. "Risks look skewed for a break below AUD/GBP 0.54 or GBP/AUD above 1.85."

Callow says the Australian Dollar, after losing 8% against the U.S. greenback in 2018, has scope to recover against some rivals during the weeks ahead but that rallies will be "capped" by the currency's role as a "proxy for U.S.-China trade relations".

It is an anticipated escalation of tensions between the world's two largest economies that leads Callow to warn of a break to the upside for the Pound-to-Aussie rate. Australia's currency is, after all, heavily influenced by prices of commodities that underwrite the Antipodean unit as well as sentiments toward the economy of its largest trade partner, China.

However, and while Westpac are warning of an upward leg for Sterling against the Aussie, the Morgan Stanley team are betting accordingly. They have advocated that clients of the bank buy the Pound-to-Aussie rate around the 1.80 threshold and target a move up to 1.90.

"AUD remains on a bearish trajectory relative to GBP. While shortterm political risks associated with the leadership transition have decreased, medium-term policy uncertainty remains with the government trailing the main opposition Labour party by a wide margin," says Gek Teng Khoo, an FX strategist at Morgan Stanley. "Positive Brexit-related headlines should also keep GBP supported. UK data continue to outperform, most recently GDP data and an upside surprise to wages"

NAB Eyes Pound-to-Aussie Losses

For all of the bearishness from Morgan Stanley and Westpac, not all analysts monitoring the Australian Dollar have such a downbeat view of its prospects.

The National Australia Bank (NAB) team say in their latest review of currency markets that they aren't throwing in the towel on their bullish 2018 forecasts just yet.

"Our long-standing end-September 2018 forecast of 0.73 looked forlorn a week ago but seems much less so today. And while our end-2018 pick of 0.7500 looks ambitious, we are not rushing to revise it lower. Four months is after all a very long time in FX markets," says Ray Attrill, head of FX strategy at National Australia Bank. "We’ll see how trade issues

look to be developing in coming weeks before making a call on possible revisions."

In contrast to the upbeat views of Morgan Stanley and Westpac, Attrill and the NAB team are forecasting that the Pound-to-Australian-Dollar rate will fall from 1.71 Tuesday to 1.66 by year-end, largely due to outperformance by the Aussie Dollar and underperformance from Pound Sterling.

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Secure these elevated GBP/AUD rates. 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