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- AUD declines Friday despite retail sales beat for August.

- Sales rose in August, iPhone launch to boost in September.

- Westpac say AUD has bottomed, but ANZ is more cautious.

The Australian Dollar slipped to a fresh two-year low Friday despite a stronger-than-expected set of retail sales numbers for August, although analysts at Westpac are saying the worst is now over the Antipodean currency.

In the current market, which has seen the Aussie increasingly driven by global factors rather than domestic data, August's retail number had to be a show-stopper if it was to provide anything more than fleeting support to the Aussie. And although the number beat economist forecasts, it was not enough to prop up the currency.

Retail sales rose by 0.3% during August, a definitive improvement on the 0% change seen back in July, when markets had looked for sales growth of just 0.2%. This drove the annual pace of retail sales growth up to 3.4%, from 3.2% previously.

Growth was strongest in the states of Tasmania, New South Wales and Victoria. Western Australia and the Northern Territory both saw retail sales contract by -0.1% and -0.5% respectively, according to the Australian Bureau of Statistics.

"The August result was an at-trend read. It appears that some political uncertainty ahead of the Federal Government leadership change (August 24) did not deter consumer spending. However, note that the Westpac-MI Consumer Sentiment survey moderated in September with three major banks raising standard variable mortgage rates around the turn of August/September," says Simon Murray, an economist at Westpac.

Murray says that with several domestic lenders having raised their variable mortgage rates during September, consumer confidence and retail sales may suffer in the future.

But Murray tempers his caution by noting the launch of another iPhone model last month, which could have positive implications for the retail numbers released in November, which will cover September.

"Over a longer-term, we still see subdued household income growth as the major constraint on consumer spending with a likely negative wealth effect from the decline in home prices an additional headwind," Murray writes, in a note to clients.

Markets care about the retail data because it is a leading indicator of economic growth and because of the influence that rising or falling consumption can have on inflation. It is inflation that central banks are attempting to contain when they raise interest rates, and rates themselves are the raison d'être for most moves in currency exchange rates.

Changes in interest rates, or hints of them being in the cards, are only made in response to movements in inflation but impact currencies because of the push and pull influence they have on international capital flows and their allure for short-term speculators.

"Westpac is retaining its target for AUD to end 2018 around USD 0.72. Further weakness is expected for the AUD through the first half of 2019, bottoming out at USD 0.70 around the middle of 2019 before recovering somewhat to USD 0.72 by end 2019," says Bill Evans, chief economist at Westpac, in a separate report.

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Global Environment Still Threatens the Aussie

Westpac's currency team says the Antipodean currency can recover from two-year lows before year-end and that this week's pricing should mark a nadir for the Aussie. But other local analysts are less optimisitic.

"The domestic data flow remains positive, but this is well understood by markets and largely priced in. Importantly, the global environment continue to dominate moves, and on this front we see a number of risk events ahead (US-China tensions, Brexit, mid-term elections) that could end up taking a toll on the AUD," says Daniel Been, head of FX research at Australia & New Zealand Banking Group (ANZ).

The retail data comes after Federal Reserve (Fed) chairman Jerome Powell told an audience at The Atlantic Festival that U.S. interest rates are still a "long way" off from the so-called neutral level and that its benchmark lending rate could even cross that threshold eventually.

The comments prompted a renewed sell-off in American bond markets, which pushed the 10-year Treasury yield to a seven-year high above 3.2% Thursday, drawing a fresh bid for the U.S. Dollar.

"Interest rates are still acommodative, but we're gradually moving to a place where they will be neutral," Powell said in discussion with Judy Woodruff of PBS NewsHour. "We may go past neutral, but we're a long way from neutral at this point, probably."

This has further widened the already-negative yield differential between bonds of the Australian and U.S. government. For the last two decades, Aussie interest rates have typically been higher than those of the Fed, while Aussie yields have typically been higher than their U.S. counterparts.

That yield differential, once a source of material support to the Australian Dolllar, is now becoming an increasingly heavy weight around the ankles of the Antipodean currency given current Reserve Bank of Australia (RBA) policy.

The RBA has held its interest rate at a record low of 1.5% for more than two years now while the Fed has raised rates eight times since the end of 2015, taking the top end of the Federal Funds rate range to 2.25%.

"We’re concerned that the high probability of President Trump proceeding to both lift the recently imposed 10% tariff rate on $200bn worth of Chinese imports to 25% and to extend this to the full gamut of Chinese imports (i.e. another $267bn or so) is not fully priced by markets," says Ray Attrill, head of currency strategy at NAB, a division of Bank of New Zealand. "If this is how trade relations develop, one response from China will be to orchestrate a further, modest, CNY depreciation."

In addition to the interest rate headwind Australia's Dollar is also suffering as a result of President Donald Trump's trade war with China, given the currency is undewritten by the nation's commodity exports to the world's second largest economy.

For that reason, the Australian Dollar often serves as a surrogate for speculators seeking to express bearish views about China's state-managed Renmimbi. If Attrill is right and the Chinese Renmimbi is devalued further during the months ahead, then losses for the Australian Dollar are almost certain to follow.

Prices of commodities are also heavily influenced by investor sentiment toward China's economy so if expectations for Chinese growth were to be dented by an escalation of the trade conflict, the Australian Dollar could also suffer as the price of iron ore, coal and liquified natural gas declines.

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