- AUD forecasts downgraded at St George Bank but worst is over.

- AUD still faces unprecedented uncertainty but losses mostly in already.

- AUD/USD rill rise modestly in 2018/19 while GBP/AUD gains are limited.

© Filipe Frazao, Adobe Stock

According to the latest forecasts from Australian lender St George Bank, the Aussie Dollar has finally found a new floor after months of heavy losses.

Economists at St George Bank took an axe to their forecasts for the Australian Dollar in a mid-year update on the currency and economy; nevertheless the new projections still show the Aussie unit is unlikely to fall much further during the rest of year.

Australia's Dollar is down by 5.4% against its US rival and around 3.5% against Pound Sterling so far in 2018 as markets turn against currencies whose central banks are not in a regime of raising their interest rates, as is the case of the Reserve Bank of Australia. An emergent global trade war sparked by the U.S. and a financial market sell-off in China have meanwhile added to the Aussies headache.

"A key question for the currency outlook is whether some of the recent drivers bringing down the Australian Dollar have a longer-lasting impact. Given that uncertainty surrounding global trade negotiations is likely to persist for some time and given that we do not expect the risk aversion in financial markets to subside substantially over the near term, we have downgraded our Australian dollar forecasts," says Besa Deda, chief economist at St George Bank.

Tensions over international trade and resulting risk aversion in financial markets are just the latest ailments of the Australian Dollar. Until May, volatility in commodity prices and a deteriorating outlook for Reserve Bank of Australia monetary policy had kept the Aussie under the proverbial cosh on currency markets. Going forward, the trajectory of the currency will be determined by a combination of all these things.

"The US federal funds target rate also moved above the Australian cash rate on June 14 for the first time since late 2000. It begs the question of what interest-rate differentials mean for the AUD outlook," Deda writes, in St George's biannual market outlook. "The differential between US and Australian two-year government bond yields has been narrowing as a trend since early 2011, and has turned negative (US yields have exceeded Australian yields) since January 26 this year."

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Get up to 5% more foreign exchange by using a specialist provider to get closer to the real market rate and avoid the gaping spreads charged by your bank when providing currency. Learn more hereThe Reserve Bank of Australia has now held its rate at a record low of 1.5% for nearly two years, citing below-target inflation and a debt laden household sector that it says is ill-equipped to handle the pressures of higher borrowing costs following years of weak wage growth. Meanwhile, the Federal Reserve has raised US rates twice in 2018, taking US rates above their Aussie counterparts, and is on course to do so twice more before the year is out.

This has had a severe impact on the Australian Dollar, which has long enjoyed support from interest rates that were for-a long-time higher than those elsewhere in the developed world. The AUD/USD was trading around $0.50 back in the year 2000, which is the last time interest rate and bond yield differentials moved so heavily in favour of the US Dollar.

"The US economy has become a standout in the world economy. US economic growth has regained strength towards the June quarter of this year, while growth in other major economies, including Europe, China and Japan, has lost some momentum in the first half of this year. It has helped to lift the US dollar index to an eleven-month closing high of 95.31 on June 28. In contrast, the RBA is not expected to lift official interest rates any time soon," Deda notes.

Deda says that pricing in overnight-indexed-swaps markets attaches a 68% probability to the prospect of an RBA rate hike coming before the end of 2019 and that the implied prospect of a hike before June 2019 is just 39%. Commentary from other analysts suggests the odds of a rate rise in 2018 are almost zero. This and the resulting differential in interest rates could act as a hard ceiling for the Aussie during the months ahead, although it is not the only risk.

"Since earlier in the year, risk aversion has crept back into financial markets," Deda says. "When financial markets become risk averse, the Australian dollar tends to come under downward pressure. A major factor behind the lift in risk aversion is the increased downside risks to the global outlook due to fears of a global trade war."

President Donald Trump is pursuing restrictive legislation to govern investments into the United States from China, which is Australia's largest trading partner, and recently ordered that a range of tariffs be levied against imports of more than $250 billion in American imports of Chinese goods. These tariffs come into force on July 06, although earlier levies on imports of steel and aluminium from China, Canada, Mexico and the European Union are already in force.

The moves so far have drawn retaliation and threats of even further reciprocal measures from the Chinese. Fears are that a tit-for-tat tariff fight between the world's largest economies will quickly descend into an all out "trade war" and that this will dent economic growth in all countries it touches, which could stymy the Federal Reserve from raising its interest rate further while also denting the odds that other central banks will be able to raise their rates any time soon.

"We see a great deal of uncertainty surrounding the outlook for the Australian dollar. Key fundamentals, commodity prices and interest rates, are not providing a clear gauge on the direction of the AUD. Moreover, the inclination for US President Trump to backflip on policies suggests that there is significant uncertainty to the global economy and, therefore, the Australian dollar outlook," Deda says.

Forecasts for the Australian Dollar

Deda and the St George team say much of the Australian Dollar's fortune over the coming year will be dicated by things that are highly unpredictable, like whether or not the world decends into an all out trade war or if one is avoided. But the combination of uncertainty over trade and developments in Australia's current fundamentals still warrant a downgrade of their earlier forecasts.

They now predict the AUD/USD rate will close the 2018 year at 0.74 before rising gradually to 0.76 over the course of 2019. This is a significant downgrade from their earlier projection that the Aussie would rise to 0.84 this year.

The Pound-to-Australian Dollar exchaneg rate is forecast to rise steadily in 2018 to just more than 1.81 by year end and to 1.86 before the end of 2019.

This too is a substantial downgrade for the Aussie Dollar, given St George's earlier projections had the Pound-to-Aussie rate all the way down at 1.71 by the end of 2018.

The AUD/USD rate was quoted 0.02% lower at 0.7387 during the noon session Thursday while the Pound-to-Aussie rate was down 0.19% at 1.7891.

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Get up to 5% more foreign exchange by using a specialist provider to get closer to the real market rate and avoid the gaping spreads charged by your bank when providing currency. Learn more here