- AUD slides despite strongest growth for nearly six years.

- "Trade war" and risk appetite now dominant driver of AUD.

- Data leaves downbeat interest rate and AUD outlook in place.

Image © Desiree Caplas, Adobe Stock

The Australian Dollar remains under pressure, even after official data showed the economy growing at its fastest pace for nearly six years during the second-quarter, as continued financial instability in the emerging world and a "risk-off" mood in markets overshadowed better domestic newsflow for investors.

Australia's economy grew by 0.9% during the second quarter which, although down from the upwardly-revised 1.1% pace of growth seen in the first quarter, was ahead of the consensus for growth of 0.7%. This pushed the annualised pace of growth up from 3.1% to 3.4%, its fastest since the third quarter of 2012, when markets had looked for a dip to 2.8%.

Household spending, residential investment, government spending and export trades all made noteworthy contributions to growth during the quarter although the star of the show was without doubt the Australian consumer. Consumer spending rose by 0.7% during the period, accounting for around 0.4% of the overall expansion according to the Australian Bureau of Statistics.

"The report signals that growth in the economy over the past year has been significantly stronger than we had been led to believe and, indeed, comfortably above the generally accepted measure of potential growth of 2.75%," says Bill Evans, chief economist at Westpac. "However, this comes after growth in the year to June 2017 of only 1.9% and it is likely that a longer period of above trend growth will be required to sufficiently erode the current spare capacity in the economy which would see a sustained lift in price and wage inflation."

Currency markets typically care greatly about GDP data because it reflects rising and falling demand within the economy, which has a direct bearing on consumer price inflation which is itself important for questions around interest rates. And interest rates themselves are a raison d'être for most moves in 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.

"Despite the strong GDP data and reactions this morning, both equities and the AUD have been affected by poor global sentiment this afternoon. The AUD is little changed on the day while the ASX has lost nearly 1%. The driver here appears to be EM sentiment, though it hasn’t affected bond markets as yet," says Philip Brown, a senior bond market strategist at Commonwealth Bank of Australia.

Above: AUD/USD rate shown at daily intervals.

The Australian Dollar was quoted 0.26% lower at 0.7164 against the US Dollar during the London morning Wednesday while the Pound-to-Australian-Dollar rate was 0.08% lower at 1.7879.

The Aussie was lower against all developed world currencies on the morning, barring a Brexit-stricken Pound Sterling.

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

"Interesting couple of days for the AUD. Solid GDP, and an RBA who disappointed the doves yet no rally can be sustained. Ratifies our view that the AUD is a global story at the moment. DXY and emerging markets in the driver seat," says Daniel Been, Head of FX Research at ANZ Bank.

Australia's currency has born the brunt of US economic out-performance relative to the rest of the world and of President Donald Trump's "trade war" with China and the resulting financial instability in emerging markets.

It is after all, closely tied to the fortune of commodity markets and sentiment toward the global economy, both of which have been adversely impacted by fears that an ongoing tariff fight between the world's two largest economies will lead to slower growth.

"Household expenditure growth has been sustained at a 3% pace for the last three quarters but that has been supported by a steady decline in the household savings rate," says Evans. "The wealth effect of rising house prices can be expected to be associated with a falling savings rate. However, with house prices now falling in both Sydney and Melbourne and other markets remaining soft it seems likely that the savings rate is likely to have bottomed out."

Consumer spending and overall economic growth are of heightened importance to the Australian Dollar currently, given the extent to which the interest rate outlook has deteriorated this year and the adverse impact it has had on the currency.

The Reserve Bank of Australia has held its interest rate at a record low of 1.5% for more than two year now, citing below-target inflation, weak wage pressures and a litany of risks to the outlook for inflation and growth.

Pricing in interest rate derivatives markets suggests investors do not see a change in Australian monetary policy coming until at least the second half of 2019. Governor Philip Lowe repeated Wednesday that the next move in the cash rate is likely to be up which, in contrast to the situation in New Zealand, means a rate cut is not yet in the cards down under.

"Only yesterday the RBA had stuck to its view that a rate hike was a long way off yet, despite the fact that the economy is moving in the right direction, as today’s data confirms. That makes it clear that AUD strength will arrive later than we had envisaged, but it will arrive. The longer the aussie remains at the current weak levels the more this supports the Australian economy which will lower unemployment further and fuel wage inflation sooner or later. As soon as that emerges the RBA will consider rate hikes," says Esther Maria Reichelt, an analyst at Commerzbank.

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