GBP/AUD looks for footing at 1.7414 2021 lowAUD/USD rally stalls in breather for GBP/AUDBoE, RBA & commodity windfall key to outlook

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The Pound to Australian Dollar exchange rate reached its lowest since the early days of 2021 this week but a nascent consolidation of the recent rally in AUD/USD could be likely to help it stabilise above the 1.7414 level over the coming days.

Australia’s Dollar reached its strongest against the U.S. Dollar since October during the opening session of the week before its two-month long rally stalled, offering a beleagured Pound to Australian Dollar rate a moment of respite from almost relentless selling.

AUD/USD reached 0.7540 before edging lower on Tuesday and bringing a tentative halt to a sell-off in Sterling that had placed the Pound to Australian Dollar rate on course for a ninth consecutive weekly decline.

“Lockdowns in China are likely to impact commodity sentiment in the near term, while the OPEC+ meeting could see some further weakness in crude and the Russia/ Ukraine peace talks may also weigh on prices too,” says Robert Rennie, head of financial market strategy at Westpac.

“Near term, the A$ looks capped up to the October 0.7556 highs,” Rennie and colleagues also said in a research briefing on Wednesday.

Above: GBP/AUD shown at hourly intervals alongside AUD/USD.

GBP/AUD tends to closely reflect the relative performance of Sterling and the Aussie when each is measured against the U.S. Dollar.

AUD/USD's rally stalled after trade partner China’s largest city economy, Shanghai, was placed in 'lockdown' as authorities seek to contain the Omicron coronavirus strain which had only recently led restrictions to be implemented in the economic hub of Shenzhen.

“If the Shanghai government cannot curb the spread, local governments in other cities may not succeed unless they impose harsh lockdowns. The potential economic costs of widespread lockdowns could be quite high,” says Kristina Clifton, a senior economist and currency strategist at Commonwealth Bank of Australia.

Sterling would likely stabilise above this week's low of 1.7414 if AUD/USD remains stalled, although much also depends on whether the Pound itself will be able to avoid further losses after coming under pressure almost from the open on Monday.

Above: Pound to Australian Dollar rate shown at weekly intervals with Fibonacci retracements of 2021 rally indicating possible short-term levels of technical support for Sterling. Click image for closer inspection.

The Pound fell widely after Bank of England (BoE) Governor Andrew Bailey reiterated that the ongoing commodity-induced squeeze on incomes will potentially act as a substitute for some of the additional increases in interest rates that financial markets have taken as given for later this year.

“We are watching very carefully but facing very high levels of uncertainty as to what is the right combination of what I said earlier was the ‘natural and quite substantial hit to real income’ - this terms of trade shock that we’re facing - and the right use of monetary policy,” the governor told the economic policy think-tank Bruegel on Monday.

“We recognise that the overall effect on inflation will be the sum of the two and I think the shock to real income is larger, and I think many commentators say this, than the single effect of monetary policy. But monetary policy is important. Not least because we have to guard against second round effects,” he added, in a discussion about macroeconomic and financial stability.

While Governor Bailey did indicate that some further increase in Bank Rate is likely to be necessary if the BoE is to return is monetary policy settings to a calibration that no longer adds to inflation pressures in the economy, he also said the commodity price shock is likely to subdue the economy and could eventually reduce domestically-generated inflation of its own accord.

Above: AUD/USD shown at weekly intervals with Fibonacci retracements of November 2021, June 2021 and February 2021 downtrends indicating possible areas of technical resistance to a further Aussie Dollar recovery. Includes selected moving-averages. Click image for closer inspection.

The implication is that some of this effect could be used to reign in inflation in place of increases in interest rates, meaning that investor expectations for Bank Rate to rise from 0.75% in March to 2% or more by year-end are likely on the excessive side of what may be feasible for the coming months.

The commodity price rally underlying this squeeze on incomes is a windfall gain for the Australian economy and Dollar, however, and one that was valued by the government at some A$114bn for the four years to 2025 in Wednesday’s budget.

But for as long as the rally in AUD/USD remains stalled, the decline in GBP/AUD could be likely to slow for a period if it doesn't partially reverse as market attention turns to next week’s Reserve Bank of Australia (RBA) policy decision.

“Almost $40bn of new spending (or revenue reductions) across the five years from 2021-22. Importantly, more than half is set to occur in the current financial year and 2022-23,” says David Plank, head of Australian economics at ANZ, of this week’s budget.

“This adds to demand at a time when the economy is already strong. When the RBA starts to hike, we expect it to move with some vigour and the cash rate to reach 2% by the end of 2023,” Plank and colleagues also said on Wednesday.

Above: Pound to Australian Dollar rate shown at weekly intervals with Fibonacci retracements of 2017 rally indicating possible longer-term levels of technical support for Sterling. Click image for closer inspection.