GBP/AUD supported by BoE-RBA divergenceSupported above 1.89 but stymied near 1.92AUD eyeing RBA testimony as outlook weighsAUD/USD’s struggle aids GBP/AUD’s uptrend

The Pound to Australian Dollar rate could remain elevated above 1.89 and near to 20-month highs this week if the Reserve Bank of Australia’s (RBA) policy stance weighs further on the Aussie or if the greenback is lifted by the release if U.S. inflation data.

Australia’s Dollar opened the new week on its front foot, potentially as a result of the government’s decision to reopen its economically significant tourism sector to the outside world, although the Aussie had ceded ground to the Pound, Euro, U.S. Dollar and a range of other currencies last week.

The Aussie came under pressure after the RBA continued to express scepticism about the market’s outlook for Australian wage growth and inflation, an outlook which has seen investors and traders wager heavily in recent months that the bank could be likely to lift interest rates repeatedly in 2022.

“The Australia minus US ten year bond differential has slumped close to zero again. A dip in the differential below zero can weigh strongly on AUD. The RBA’s communications last week were dovish, especially compared to the ECB’s inflation pivot and the BoE’s 25bp rate hike,” says Carol Kong, a currency strategist at Commonwealth Bank of Australia, who’s warned of a possible dip back toward 0.70 for AUD/USD in the near future.

The RBA’s February policy decision and subsequent remarks from Governor Philip Lowe did little to help the Aussie after both the bank and governor reiterated doubts that wages could grow sufficiently in the months ahead to sustain inflation at the targeted 2.5% target level once temporary influences that have recently lifted prices begin to wane.

Above: GBP/AUD at daily intervals with Fibonacci retracements of December rally indicating possible areas of support for Sterling.

GBP/AUD reference rates at publication:

Spot: 1.9005High street bank rates (indicative band): 1.8340-1.8473Payment specialist rates (indicative band): 1.8834-1.8910Find out about specialist rates, hereSet up an exchange rate alert, here“Markets will now have to wait for the Q4 2021 wage price index (23 February) and Q1 2022 CPI (27 April) to assess how inflation and wages are evolving compared to the RBA’s forecasts. We expect wages and CPI inflation will outpace the RBA’s forecasts in H1 2022 and trigger a lift in the cash rate in August 2022. But a rate hike by the RBA in August will be of little help to AUD because it is already priced-in,” Kong said on Monday.

The RBA has remained insistent that its cash rate is unlikely to rise much before the year 2024, which is a position that has weighed on Australian government bond yields to the detriment of Australian Dollar exchange rates while in turn supporting the upward trend in GBP/AUD.

Meanwhile, the Bank of England (BoE) has lifted Bank Rate for a second consecutive time and released forecasts suggesting that further increases are possible during the months ahead, while the European Central Bank (ECB) has also joined the growing ranks of others concerned about inflation.

“We stuck last week to the view that the “A$ will remain capped by the 0.7145/60 level” and that proved to be the correct view given the hawkish twists from central bankers last week, the enormous sell off in global bond markets and the super strong US NFP report. That has left the A$ dropping sharply versus the EUR and GBP and given the RBA guidance last week,” says Robert Rennie, head of financial market strategy at Westpac.

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Last week’s central bank updates in Europe lifted Sterling and the Euro sharply against the Aussie, leading the Pound to Australian Dollar rate to reach highs just above the 1.91 handle, and could continue to offer support to the GBP/AUD and EUR/AUD exchange rates over the coming days.

This would be especially likely if Westpac is right in expecting the main Aussie exchange rate, AUD/USD, to remain beneath 0.7160 and even more so if CBA on the money in looking for AUD/USD to slip back toward the 0.70 handle over the coming days and weeks due to low level of Australian government bond yields when compared with their U.S. counterparts.

“The A$ should continue to underperform on crosses despite super strong commodity prices with met coal close to record highs and surprisingly strong iron ore prices. We expect to see some further weakness versus the US$ too as the Fed moves to begin its aggressive tightening program in March. We would look to use that dip to buy,” Wesptac’s Rennie and colleagues wrote in a Monday briefing.

GBP/AUD tends to closely reflect the relative performances of the main Sterling exchange rate GBP/USD and its Australian counterpart, AUD/USD, but also often demonstrates a negative correlation with the latter.

Above: AUD/USD at daily intervals with Fibonacci retracements of January decline indicating possible areas of technical resistance to a further recovery. Shown with selected moving-averages and alongside GBP/AUD.

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GBP/AUD would likely hold comfortable above the 1.89 handle this week if AUD/USD struggles to get above 0.7160 and if, at the same time, the main Sterling pair GBP/USD is able to hold above an important level of support around the 1.35 handle.

There would, however, be little chance of the Pound to Australian Dollar rate rising above its current 20-month high of 1.9222 for the entirety of the time that AUD/USD’s recent lows around 0.6968 remain intact.

Whether AUD/USD’s low does remain in place will be in part determined by the market’s response to this Thursday’s appearance by RBA Governor Lowe before the House of Representatives Standing Committee on Economics, as well the U.S. Dollar’s response to Wednesday’s inflation figures for January.

“We think the RBA’s wages outlook is too pessimistic which lies behind our expectation that the RBA will begin raising the cash rate in the second half of 2022,” says David Plank, head of Australian economics at ANZ.

“The January US CPI release this week will be closely watched for the extent of inflation pressures. Owing to very high energy prices and a broadening in underlying inflation pressures, the risks lie to the upside of the market’s 7.3% y/y forecast,” Plank and colleagues said on Monday.

The danger for the Australian Dollar is that Wednesday’s inflation data surprises on the upside of market expectations and lifts U.S. government bond yields, which would further disadvantage the Aussie relative to the U.S. Dollar.

That would, in turn, very likely provide the Pound to Australian Dollar rate with a supportive tailwind.