The Australian Dollar reacted warmly to news that the Australian construction sector is likely to provide a boon to the economy in 2018.

The Australian Dollar outperformed rivals in the wake of a data that showed the Australian construction sector is likely to see an acceleration in activity in 2018.

Residential building permissions granted to Australian construction firms rose by 11.7% during the November month, when compared with October, while economists had expected a contraction in planning consents.

The consensus-busting data is expected to feed into the broader economy over coming months and will therefore likely provide a supportive underpinning to the Aussie Dollar.

"The ongoing strength of residential approvals, both detached houses and apartments, points to an extended high level of construction activity. It has a high multiplier effect on the broader economy," says Michael Workman, an economist with CBA in Sydney.

Workman says today’s "extraordinary 11.7% rise" is significant and has positive implications for material providers, construction groups, real estate professionals and big box retailers across the economy. "Let’s not forget the landscape & lifestyle suppliers," says Workman.

CBA observe that residential approvals have been above an annual rate of 220k through 2017 which indicates a prolonged period of new dwelling construction which is needed if national population growth stays near 380k over the next few years.

Strong population growth in Melbourne and Sydney are expected to continue soaking up the record levels of apartment construction.

“Residential building approvals consistently performed better than expected in 2017, as weakening demand conditions and oversupply in the higher-density sector were offset by a late cycle surge in property development lending by foreign banks and non-bank lenders,” says Sally Auld, chief Australia and New Zealand economist at J.P. Morgan, in a recent note.

Much of the increase was the result of growth in apartments and other non-house forms of residential dwelling, with the overall seasonally adjusted value of residential building rising by 14.8% during the month. Read more about the current state of the Australian property market here.

“This should be a temporary state of affairs, however, as approval flow is likely to slow now that end-user demand by investors has cooled sufficiently,” says Auld.

The Australian Dollar caught a new bid off the back of the report’s release, which came closely on the heels of 15 days of gains for the currency.

"Significantly better than expected November building approvals boosted the AUD/USD early today and we note short term implied valuations attempting to inch higher again," says Emmanuel Ng at OCBC.

However it appears the gains for the currency have been short-lived in nature as AUD/USD rose to a high of 0.7864 before fading back to 0.7815.

The GBP/AUD fell to a low of 1.7238 before Sterling was seen recovering allowing the rate to rise to 1.7304.

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

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Get up to 5% more foreign exchange by using a specialist provider by getting closer to the real market rate and avoid the gaping spreads charged by your bank for international payments. Learn more here.Traders will now be turning focus on Wednesday’s forthcoming retail sales number.

“The monthly data suggested something of a stabilisation in October (+0.5%m/m), and we expect a similar result in next week’s report for November (+0.4%m/m), on the basis of firmer industry surveys of card spending. However, this will not be sufficient to lift the trend rate of sales growth,” says Auld ahead of the release.

Auld’s forecast for Wednesday’s retail number is in line with the consensus among economists for growth of 0.4% although traders are, quite understandably, exercising caution ahead of the report’s release.

“We've seen manufacturing and construction activity ease into year end while service sector activity advanced ever so slightly. These reports show economic activity waning and if this week's retail sales report also falls short of expectations, we could see a more material correction in the currency,” says Kathy Lien, a managing director of foreign exchange strategy at BK Asset Management.

Australian retail sales numbers were a blight on the Aussie Dollar throughout much of 2017, but particularly in the second half of the year, mainly due to perceived economic uncertainties and weak wage growth across the Antipodes.

In October, the most recent month for which data is available, spending rose by a modest 0.5%, although this came after a quarter long period of decline and underperformance.

August’s report, which saw a contraction in retail sales of 0.6%, was the worst performance from the Australian high street since March 2013. But it wasn’t in isolation as the decline came sandwiched between two separate months where sales ground to an outright halt, with zero growth.

Retail sales are an important indicator of confidence, and the overall financial health, of Australian households. Household confidence and financial wellbeing is itself a key input into Reserve Bank of Australia (RBA) interest rate decisions.

Reserve Bank and Rates in Focus

So far, low inflation, weak wage growth, high household debt levels and uncertainty over the economy have served to keep the Australian cash rate static at 1.5% and the RBA on the sidelines.

Meanwhile, central banks elsewhere have begun to raise rates and exit their crisis-era policies, notably the Federal Reserve, Bank of Canada, Bank of England and European Central Bank.

This is a challenge for the Aussie Dollar and those hoping to see a rise in the currency as it will mean other developed world bond yields are rising at the same time as Australian yields sit largely unchanged, or flat.

Such divergence can undermine the Aussie Dollar by reducing the relative yield premium investors have typically earned by holding Australian bonds over those of other countries.

A sustained recovery in consumption and a durable uptick in wage growth would probably be required in order to have the RBA to consider joining the crowd by raising its interest rate.

Until then, strategists advocate that traders exploit the divergence between Australian monetary policy and that elsewhere across the developed world, with one popular trade being to bet on a fall in the Australian Dollar relative to the Canadian Dollar.

“An oil price breakout was expected to be most meaningful for those currencies where output gaps have already closed and the central bank is normalizing. CAD was thus a prime candidate which we had initiated vs. AUD as RBA is expected to remain on the sidelines,” says Meera Chandan, a strategist at J.P. Morgan, in a recent note.

The J.P. Morgan team are using Option, which are complex derivatives, to bet on a fall in the Australian Dollar relative to the Canadian Dollar. They have also suggested a steep fall in the NZD/CAD rate is possible during the months ahead.

“Industrial production data and the Dec jobs report may help fuel a small positive repricing at the front-end of the CAD rate curve and take USD/CAD below 1.25,” writes Viraj Patel, a strategist at ING Group, in a note last week. “A hawkish BoC is also why we expect AUD/CAD to move lower.”

Patel has an initial target of 0.96 assigned to the AUD/CAD pair, which implies downside of around 1.5% from the current 0.9740 level. The AUD/CAD rate was trading above 0.9800 at the time Patel’s note was released.

You can read more about what analysts expect from the Australian Dollar during the year ahead here.

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Get up to 5% more foreign exchange by using a specialist provider by getting closer to the real market rate and avoid the gaping spreads charged by your bank for international payments. Learn more here.