Downtrend to Meet Hard Floor of Support, Much Depends on RBA Decision

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- GBP/AUD falling to thick layer of support in 1.80-81s

- More downside could be difficult and bounce possible

- Subject of May’s replacement to impact Pound

- RBA meeting key for AUD

The Pound has been under pressure against the Australian Dollar of late but the GBP/AUD exchange rate is now approaching solid areas of support while much of the price action this week will depend on the RBA interest rate decision.

The Pound lost 2.80% in value against the Australian Dollar over the course of May with the UK currency losing ground against all its major competitors.

The GBP/AUD exchange rate will be trading at 1.8208 at the week's market open, more than a cent and a half lower than where it was one week ago.

The Aussie gained over the course of the past week as commodity prices rose, with Iron Ore, Australia’s key export rising to above $98.00 a tonne while Sterling fell on fears the next Prime Minister might be a Brexiteer who would look to deliver a 'Brexit at all costs' come October 31.

From a technical perspective, the established downtrend remains intact and likely to continue. Nevertheless, there is a tough zone of support coming up in the 1.80-81s which is likely to provide a floor to the exchange rate and the trend is at risk of stalling in the near-term.

The main impediment to further downside is the 200-day moving average (MA) at 1.8159 which is likely to provide a very firm layer of support.

The April lows at 1.8100 are another layer.

The 50-week and 200-week MAs are at 1.8067 and 1.8088, are also likely to add ballast to the support.

All-in-all, we would need to see these levels clearly breached by a close below 1.8050, or a break below 1.8000 for confirmation of a continuation of the established downtrend lower to the next targets at 1.79, and the 1.78.

Eventually, it is quite possible the pair could break below these levels too. The weekly chart shows how the pair appears to have been forming a bearish chart pattern called a broadening formation (BF). These appear when the market range widens due to heightened volatility. The BF is normally composed of five waves, labeled A-E, and this pattern is probably currently unwinding lower in wave E, which could go all the way down to the lower 1.70s eventually.

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The Australian Dollar: What to Watch

Australian data out last week was mostly worse than markets were expecting and solidified the expectation that the Reserve Bank of Australia (RBA) will announce a cut to interest rates at its Tuesday, June 4 meeting, scheduled for 05.30 BST.

Previously analysts had been unsure of whether they would go ahead, but the -1.7% miss to capex when a 0.5% rise had been forecast, and equally outsized miss to building approvals (an indicator of the state of the vulnerable house market) which shrank -4.7% when a 0.1% rise had been forecast, provided the final nails in the coffin, and a cut is now the dominant expectation.

Investors tend to send their capital to countries offering greater returns, and when interest rates are rising at a central bank the inflow of capital into the country seeking higher returns can result in that country's currency being bid higher.

The opposite dynamic is at play when central banks are cutting interest rates: and this is the cycle Australia and it's dollar now find themselves in.

However, this week's interest rate cut has been well advertised and will almost certainly now 'be in the price', therefore what matters is the guidance provided by the RBA as to future interest rate cuts.

If the signal is that more are indeed coming, then expect further AUD weakness on the day. However, a wait-and-see approach with a relatively upbeat tone could well see the AUD rally.

"AUD/USD could lift overnight despite the virtual certainty the RBA cuts the cash rate to 1.25% (5:30am London). A 25bp cut to the RBA cash rate is over 100% priced. Therefore, unless the RBA flags the likelihood of more cuts in the accompanying statement, AUD will lift. History suggests that the RBA tends to play a straight bat and so the RBA statement is more likely to be neutral on the outlook for rates, rather than signal more RBA rate cuts," says Kim Mundy, an analyst with Commonwealth Bank of Australia.

One of Australia's largest banks, Westpac, are now forecasting three cuts at the RBA in 2019. with forecasts for employment, wages growth, economic growth, inflation and conditions in the housing market consistent with the need for policy at the central bank to ease through the full course of 2019.

"Our central forecast for the terminal cash rate in this cycle is 0.75% with risks to the downside, although we would certainly see 0.5% as the floor for the cash rate, with QE a more effective policy tool thereafter," says Robert Rennie, head of research at Westpac. "The revised terminal cash rate has implications for our AUD and fixed rate forecasts. While back in February we expected the low in the AUD to be USD 0.68 we have now shaved that forecast back to USD 0.66 by end 2019."

Westpac forecasts the Australian Dollar will fall by 4.3% against its U.S. rival before the year is out, taking the AUD/USD rate down to 0.66, although this assumes a continued resilient performance from commodity prices. Without a robust iron ore price, the Aussie's losses could well be greater.

Meanwhile, the Pound-to-Australian Dollar rate is forecast by Westpac to rise another 5.4% by the time the curtain closes on 2019, taking it up to 1.92. That would be the exchange rate's highest level since the Brexit referendum of June 2016.

Clearly, there is a risk the RBA does not go ahead and cut rates and due to the surprise factor, this outcome could cause a lot of volatility and drive the Aussie higher.

Major economic data releases for the Aussie include Q1 GDP data out at 02.30 on Wednesday, June 5; and Retail Sales out at the same time on Tuesday. The current account is also out at the same time as retail sales although it is rarely a major market mover and is mostly only useful for providing background information.

GDP data is forecast to show a slower 1.7% rise in Q1 compared to a year ago (yoy) which is lower than the 2.3% of Q4.

On a quarterly basis, it is expected to rise 0.4% compared to Q4, which only showed a 0.2% rise.

This seems to suggest that Q4’s stronger yoy growth was more down to the weakness of Q4 2017 than the strength of the rise in Q4 2018.

Retail sales are forecast to show a 0.2% rise compared to the previous month of March.

The current account deficit it forecast to have narrowed to -2.5bn in Q1 from -7.2bn in Q4. This is probably partly attributable to the rise in commodity prices during that period. An even higher rise might encourage the AUD to catch a bid.

The Pound: Politics and PMI Data Dominate

The main focus for the Pound over the coming week will continue to be political, as the ruling Conservative Party prepares to choose its next leader and the country's next Prime Minister.

Key for Sterling will be the future leader's stance on Brexit.

The current favourite, Boris Johnson is a known 'Brexiteer', and recently said that if he were PM, he would take the UK out of the EU on October 31 “with or without a deal”.

Johnson is more popular amongst the Conservative party membership than amongst Conservative party MPs, and there is the chance the parliamentary party won't even select him to form party of the final pair of candidates that are voted on by the party's membership.

The contest is composed of several rounds. The first is held in Parliament and only involves Conservative MPs in the vote to decide a shortlist of two who are then put to a broader vote amongst party members. If Johnson can get into the final shortlist he will probably be next leader.

"The No Deal Brexit option will likely be the defining feature of the Tory leadership contest, as opposed to a leverage tool to be used primarily to extract better conditions in negotiations with the EU. This possibility becomes more urgently negative for GBP and for UK assets if one expects, as our economists do, that Boris Johnson may be inclined as a newly minted PM to call for new elections, aiming to create a parliamentary arithmetic that does not preclude a No Deal outcome," says Shahab Jalinoos, a currency strategist with Credit Suisse.

Jeremy Hunt is the favourite amongst the party membership at present, and he opposes a 'no deal' Brexit.

Regardless, whichever candidate espouses the toughest line on Brexit and potential future negotiations with Europe will likely win the final vote held by the party's membership.

The EU said it has not changed its stance on Brexit after May’s resignation, and that “our position on the withdrawal agreement — there is no change to that,” according to EU spokesperson Mina Andreeva.

This has increased downside pressure on Sterling because if the EU is unwilling to negotiate a better deal, and the next leader is a Brexiteer, it increases the chances of a 'no deal' Brexit in October.

Further complicating the outlook for Sterling is the possibility that in the event the UK were about to leave without a deal Parliament does have the power to vote down the government in a vote of no-confidence. The chancellor Philip Hammond, for one, has already said he is so against a ‘no-deal’ that he would vote against his own party if such an eventuality happened, in order to put “the national interest before party interests”.

If the government were voted down in a vote of no-confidence there would probably be a general election with an uncertain outcome. Article 50 would probably have to be revoked in the interim with considerable consequences for the chances of a Brexit ever being revived.

The outlook is decidedly murky, and therefore it is difficult to see Sterling enjoying any upside potential until this raft of issues are decided and certainty is returned to the political outlook.

On the economic data front, the main release on the horizon for Sterling are the IHS Markit PMI surveys.

The Manufacturing PMI survey is forecast to show a fall to 52.1 from 53.0 in May. This is still above the threshold for expansion of 50 but shows slowing activity. The results are released on Monday, June 3 at 08.55 BST.

PMI’s are widely acknowledged to be reliable forward indicators of growth and so a lower-than-expected reading would probably result in a decline in the Pound and vice versa for a higher-than-expected result or rise.

Construction PMI is out on Tuesday, and forecast to remain unchanged at 50.5.

Services sector PMI is out on Wednesday 5, at 9.30 BST and it is forecast to show a rise to 50.6 from 50.4.

This is the release most likely to have an impact on Sterling as the services sector accounts for over 80% of UK economic activity and therefore offers a better gauge on where the overall economy is headed.

Besides PMIs, there is potential for volatility from the testimony of Mark Carney and other Bank of England officials as they are questioned by the Treasury select committee on Monday, however, he and his colleagues are likely to defer an opinion on interest rates until there is greater clarity on Brexit.

Halifax house prices are out on Friday at 13.30 and expected to show a slowdown in house prices in May, with a 4.5% rise compared to a year ago (down from 5.0% in April) and 0.1% monthly rise compared to 1.1% in the previous month.

Time to move your money? Get 3-5% more currency than your bank would offer by using the services of foreign exchange specialists at RationalFX. A specialist broker can deliver you an exchange rate closer to the real market rate, thereby saving you substantial quantities of currency. Find out more here.

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