GBP/AUD supported above 1.8500, eyeing 1.88+But upside limited by AUD’s attempted comebackAU job & CPI data due in late Jan, key to outlookBut UK, U.S. data & USD eyed through early Jan

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The Pound to Australian Dollar rate edged higher to open the new year and could be on course to probe above the nearby 1.88 handle through the early days of January, although upside remains limited by a recently buoyant Australian Dollar that remained on its front foot at the opening of 2022.

Australia’s Dollar was vying with Pound Sterling for the top spot among major currencies on Tuesday as both edged higher against a U.S. Dollar that was itself firmer early on in the opening week of the new year.

The Aussie’s opening gambit lifted AUD/USD back toward the 0.72 handle that was lost during the final hours of 2021 and also served to limit the advance of GBP/AUD, which built only tepidly on Monday’s climb back above 1.87.

“Favourable manufacturing activity in China offers AUD and iron ore prices some support,” says Elias Haddad, a senior currency strategist at Commonwealth Bank of Australia.

“Importantly, RBA policy dynamic will no longer be a drag on AUD/USD over the course of this year. Our base case is for the RBA to cease bond purchases in mid‑February and start normalising the policy rate in November,” Haddad and colleagues said in a Tuesday note.

Above: GBP/AUD rate shown at daily intervals.

GBP/AUD reference rates at publication:

Spot: 1.8755High street bank rates (indicative band): 1.8099-1.8230Payment specialist rates (indicative band): 1.8586-1.8660Find out about specialist rates, hereSet up an exchange rate alert, hereAustralia’s Dollar was buoyant on Tuesday after an IHS Markit survey suggested China’s manufacturing sector returned to growth in December rather than continuing the prior month’s contraction, although the Aussie was also an outperformer through much of last month also.

The Aussie benefited from a softening of the U.S. Dollar during late December, which lifted AUD/USD more than many other exchange rates and helped the antipodean currency to advance against most major counterparts while limiting Sterling’s ability to climb.

“The AUDUSD range to watch is 0.7090/7290 and I will update as the view develops,” says Daniel Docherty, a currency trader at Credit Suisse, writing in a morning market commentary on Tuesday.

The Australian Dollar’s ongoing attempt at recovery could limit GBP/AUD further in January and dates back to last month’s monetary policy decision from the Reserve Bank of Australia (RBA), which suggested its crisis-inspired quantitative easing programme could be ended as soon as February 2022.

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This leaves much riding for the Aussie on the outcome of December’s employment and inflation data due on January 20 and January 25, and especially as other central banks including the Bank of England (BoE) and Federal Reserve (Fed) are beginning to normalise monetary policies at a faster pace.

January’s employment and inflation data could see the Aussie’s recovery against the U.S. Dollar extend, which would restrain GBP/AUD’s climb, if the data is strong enough to keep markets speculating about a possible faster pace of policy normalisation from the RBA in the months ahead.

In the meantime, Sterling and the Pound-Australian Dollar rate will be sensitive to employment and inflation figures due from the UK on January 17 and 19, with the market likely looking to see if they support the prospect of a further interest rate rise from the BoE in February or soon after.

“The stronger pound has been encouraged by the BoE’s hawkish decision to follow through and start raising rates last month despite the heightened Omicron uncertainty at the time,” says Lee Hardman, a currency analyst at MUFG.

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

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“The subsequent further scaling back of market fears over Omicron disruption and the BoE’s more hawkish reaction function has encouraged the UK rate market to price in three 0.25 point hikes by this summer, although it remains reluctant to price in much further tightening,” Hardman says.

Pound Sterling recovered strongly against many currencies in late December after the BoE lifted Bank Rate in response to rising inflation risks and an ongoing employment recovery that has encouraged the market to bet that multiple further interest rate rises are likely to be seen in 2022.

This has helped the Pound to hold off a strong U.S. Dollar - which is often supportive of GBP/AUD - and could keep the Pound-to-Australian rate on a gradual upward trajectory in January unless the recovery in AUD/USD is to accelerate.

The Pound-Australian Dollar rate closely reflects the relative performance of GBP/USD and AUD/USD, and would be likely to remain buoyant above the 1.85 handle unless AUD/USD is able to rally above its December highs around 0.7277 during the weeks ahead.

“The latest IMM report revealed that short pound positions were pared back over the holiday period,” says MUFG’s Hardman. “The UK’s government’s reluctance to tighten restrictions further than their current “Plan B” has likely contributed to the paring back of investor pessimism towards the pound.”