Image © Desiree Caplas, Adobe Stock

- AUD cedes further ground on weak Chinese data.

- China manufacturing sector contracted in February.

- Data takes shine off AUD capex number, Q4 GDP report ahead.

The Pound-to-Australian Dollar exchange rate was seen hovering near a four-month high at 1.8688 at the turn of the new month on the back of a combination of falling Brexit risks in the UK and Aussie-negative newsflow out of Asia.

The Australian Dollar complex weakened on Thursday in response to signs of a further contraction in the Chinese manufacturing sector during February, which has helped the Pound-to-Aussie rate to a fresh four-month high, due to fears that China's economic problems will also impact upon the domestic economy.

China Federation of Logistics and Purchasing PMI data pointed toward a further contraction of manufacturing output this month, with the index falling from 49.5 to 49.2 when markets had anticipated an unchanged reading. That number is consistent with an ongoing recession in the sector.

This is a problem for the Australian Dollar because the currency is substantially underwritten by a large bilateral commodity trade with Chin, which has given the Aussie a strong positive correlation with the Renmimbi. Presumably most of the minerals and resources sold to China are used by the manufacturing sector.

"We think that Chinese stimulus is ramping up to gradually offset the downside momentum, but for now we still expect some further disappointments in Chinese data in coming months," says Ebrahim Rahbari, head of FX strategy at Citi. The Pound-to-Australian Dollar exchange rate is quoted at 1.8688 in the wake of the numbers, having been as high as 1.8695 in the previous 12 hours, a level that represents a near four-month high.

PMI surveys measure changes in industry activity by asking respondents to rate conditions for employment, production, new orders, prices, deliveries and inventories. A number above the 50.0 level indicates industry expansion while a number below is consistent with contraction.

The Chinese figures dented the Aussie but came hard on the heels of final-quarter business capital expenditure data, which showed Australian companies increasing their investment spending sharply during the period while also revealing plans for a big pick-up in investment next year.

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

Capital expenditure rose by 2% in the final quarter of 2018, when markets had looked for only a 0.8% increase, which has provided an offset to the dire construction output data released Wednesday. This is good news because of what it might mean for Reserve Bank of Australia (RBA) interest rate policy.

"In the second half of 2018, at least some of the weakness in GDP is coming from soft investment spending. Yet at the same time, state governments are ramping up infrastructure spending and the private CAPEX survey is telling us that firms’ investment plans are increasing. This inconsistency suggests supply-side factors may be contributing to the softness in GDP," says David Plank, an economist at Australia & New Zealand Banking Group (ANZ).

The RBA said this month that President Donald Trump's trade war was threatening to see business investment decisions delayed and that investment is likely to be a key pillar of Aussie economic growth over the coming years.

It forecast that a pick-up in business investment will support stronger demand within the economy and faster wage growth, which are what it hopes will enable the RBA inflation target to be met without first having to cut its interest rate.

However, the bank also said that it would cut its interest rate if the economy slows further and the labour market produces a sustained increase in the unemployment rate, before noting that the risks of a rate cut being delivered over the coming quarters are finely balanced with the odds of a hike coming.

"Our Labour Market Indicator points to a period of stability for the unemployment rate rather than a sharp jump higher. If this is right, we think the RBA will look through weak GDP prints, though it will be an uncomfortable time," says Plank.

The RBA has held its interest rate at a record low of 1.5% for more than two years now, citing below target inflation as well as an economic outlook that means wage pressures are unlikely to be sufficient enough to lift the consumer price index to within the 2%-to-3% target band.

Thursday's capex data is important not only because of the RBA narrative but also because it is among the final pieces in the fourth-quarter GDP growth puzzle. GDP data will be released on Wednesday 06, March and the RBA is looking for growth of 0.5%, but economists are sceptical of that forecast.

GDP growth was just 0.3% on a quarterly basis during the three months to the end of September and, if anything, data covering the final quarter has pointed to the economy losing even further momentum into year-end.

Above: AUD/USD rate shown at daily intervals.

Given the weak state of the Chinese economy and doubts over the durability of the trade war truce between China and the U.S., a poor GDP number could see the Australian Dollar succumb to a cocktail of negative sentiment next week.

President Trump said tariffs on some Chinese exports to the U.S. will no longer rise to 25% on March 01, as had been planned, because negotiators are making progress in talks to end China's "unfair trade practices. But analysts are sceptical of the idea that a deal will actually be reached, and that it would last even if one were to be struck.

"I am cutting my long AUD view. It seems like we are caught in the “domestic bad / global good” stalemate still," says Brent Donnelly, a spot currency trader at HSBC in New York. "The market is treating the US/China thing as a done deal. It is not a done deal."

That could have positive implications for the Pound-to-Australian-Dollar rate, which has been lifted to a four-month high this week by a mixture of Antipodean weakness and market hopes that the UK's departure from the EU will eventually be delayed, if not abandoned altogether, by MPs in parliament.

The Pound-to-Australian-Dollar rate was quoted 0.03% higher at 1.8632 Thursday and is now up by 2.97% for the year-to-date, while the AUD/USD rate was -0.12% lower at 0.7140 but has risen 1.25% in 2019.

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