© David McKelvey, reproduced under CC licensing

- AUD forecasts downgraded at ANZ on souring 'risk environment'.

- Slowing global economy could mean more than 2 RBA rate cuts.

- AUD/USD to fall more than 5%, GBP/AUD rate to rise more than 8%.

The Australian Dollar is now facing further losses before the year is out, according to analysts at Australia & New Zealand Banking Group (ANZ), who've cut their forecasts for the Antipodean unit due to the anticipated effect of an escalation in the trade conflict between the U.S. and China.

Australia's Dollar had been expected to rise in 2019 from the multi-year lows it was seen at early in January but another escalation in tensions between the world's two largest economies now risks turning the U.S.-China tariff fight into an all-out economic conflict and crimping demand for the Aussie.

"Global risk sentiment has soured dramatically in the space of just a few weeks, which is bad news for the highly-cyclical AUD," says Daniel Been, head of FX strategy at ANZ, in a review of the bank's forecasts. "While the outlook for the major currencies has remained largely unchanged, we have drastically cut our forecasts for risk sensitive, cyclical currencies. We have made substantial downward revisions to our Asian currency forecasts as well as to the AUD."

Above: ANZ graph detailing performances of select risk-sensistive assets.

Australia has a significant exposure to China. It's largest bilateral trade flow is in hard commodities exported to the world's second largest economy and its currency has strong positive correlation with both the Chinese Renminbi as well as investors' appetites for so-called risk assets.

The commodity trade with China and other countries effectively makes the Australian Dollar one of those 'risk assets' and as a reuslt, the Antipodean unit rises and falls with expectations of growth in the global economy.

This is bad news in the current environment because President Donald Trump recently lifted from 10% to 25% the tariff on $200 bn of U.S. annual imports from China and threatened to impose a 25% levy on a further $300bn China's trade.

This has stoked fears for the already-slowing global economy and sent many financial markets into a fresh tailspin. The S&P 500 fell from 2,971 at the beginning of May to 2,760 on Friday. China's Shanghai Composite Index is down 5.6% for the month, but still up 16.2% for 2019.

"The Trump-led China offensive now appears to be a deliberate policy shift fuelled by hawkish White House advisors. The likely result is tariffs and export restrictions aimed at Chinese goods becoming a more enduring fixture of global trade," Been says. "How much this pressure translates to lower demand for Australian raw materials remains unclear, but it might not be so relevant for the AUD given the latter’s indifference to the recent surge in iron ore prices. The more likely transmission mechanism is risk appetite, which is under pressure in a lower growth environment."

Above: AUD/USD rate shown at weekly intervals.

Stock markets sold off with other 'risk assets' this week and the Aussie declined against safe-haven currencies like the greenback and Japanese Yen after President Xi Jingping was reported to be weighing a retaliation against the U.S. for its 'blacklisting' of Chinese telecoms and technology titan Huawei.

Huawei was added to the Commerce Departments 'Entity List' this month, which means American companies will need permission from the government before carrying out transactions with Huawei or any of its affiliates. This makes buying and selling its products in America near impossible.

Hui Xijin, Editor-in-Chief of China's Communist-Party-sponsored Global Times, said in a social media post Friday that China would soon retaliate against the White House and soon after the Commerce Ministry announced it's creating a "list of unreliable entities".

The Ministry of Commerce is yet to say exactly which U.S. companies will be added to this list or what awaits those who are eventually added to it, but the announcement demonstrates an intention within the government to match U.S. moves against China.

"Domestically, the questions are when and how much for RBA cuts. The RBA board has made the case for 50bps of easing irrespective of any deterioration in the global environment," Been writes. "Any substantial weakening in the global picture would put into question the adequacy of just 50bps of easing."

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

The Reserve Bank of Australia (RBA) is already expected to cut its interest rate twice in 2019 in order to stoke the faster economic growth it needs in order to return the consumer price index to the 2%-to-3% inflation target.

However, local analysts are increasingly contemplating whether the RBA could utlimately be forced to go further than the already-pessimistic financial markets give it credit for.

Westpac, one of Australia's largest lenders, is now forecasting three rate cuts in 2019 although the ANZ team, while conscious of the aforementioned risk, is forecasting just two rate cuts this year.

"The announcement of US16bn in US farm subsidies and Chinese threats around its rare earth mineral supplies indicate that neither administration expects a quick reversal in policy trajectory," Been warns.

ANZ forecasts the AUD/USD rate will finish the 2019 year at 0.65, which is a downgrade from the bank's earlier projection of 0.70 and is also more than 5% below Friday's 0.6916 level.

The Pound-to-Australian-Dollar rate is expected to to 1.92 before the year is out, from 1.82 on Friday, which implies a further gain of almost 8% in the second half of the year. The GBP/AUD rate is up 0.5% thus far in 2019.

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