Pound-to-Australian-Dollar Rate is Poised for More Gains as Market Eyes U.S. Tariffs and RBA Statement

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- GBPAUD up ahead of RBA statement, U.S-China tariff deadline.

- RBA statement could see an optimistic market caught on the hop.

- As U.S.-China tariff fight risks becoming a "full blown trade war".

The Australian Dollar faces a cocktail of risks this Friday that could force the Antipodean unit lower and help the Pound-to-Australian-Dollar rate to build on its recent gains in the final session of the week. 

Financial markets will be left to pour over the contents of the latest monetary policy statement from the Reserve Bank of Australia (RBA) at 02:30 Friday morning, just hours after the U.S. decision on whether to increase tariffs on imports of goods from China becomes known.

"This is a big deal in our view. We have been arguing that trade tensions is a key reason for data weakness outside the US, and particularly in the Eurozone and China," says Athanasios Vamvakidis, a strategist at Bank of America. "A further escalation from the US and a likely retaliation from China would be a full blown trade war in our view, with very negative implications for the global economy."

....Guess what, that’s not going to happen! China has just informed us that they (Vice-Premier) are now coming to the U.S. to make a deal. We’ll see, but I am very happy with over $100 Billion a year in Tariffs filling U.S. coffers...great for U.S., not good for China!

— Donald J. Trump (@realDonaldTrump) May 8, 2019

President Trump told supporters earlier this week that China had broken the deal being negotiated between it and the White House, leading markets to fear that Friday will bring the implementation of higher tariff rates on some $200 bn of goods China sells to the U.S. each year. 

Those existing tariffs will rise from 10% to 25% at midnight if a deal ending China's "unfair trading practices" is not signed and if the White House has not agreed to extend the negotiating period. 

That would return the market's focus back onto the health of the Chinese economy, the global growth outlook and, in turn, commodity prices. All of those things are important for the Australian Dollar and could help to prompt a fresh lurch lower by the Antipodean unit.

"The Australian dollar in particular – the preferred CNY proxy – will be made to feel the investors’ concerns. The Japanese yen on the other hand is likely to act as the preferred safe haven," says Thu Lan Nguyen, an analyst at Commerzbank. 

Above: AUD/USD rate at weekly intervals alongside USD/CNH rate (orange).

Australia's Dollar was rocked repeatedly last year not only because of domestic economic challenges, but also because of fears for the Chinese and global growth outlooks.

Investors tend to bet against the Aussie currency in such situations because the Chinese Renmimbi is managed by its central bank and so is not an effective tool for speculation, whereas the Australian currency often moves in response to commodity prices which are themselves influenced by the outlook for China's economy. 

Many banks are warning of fresh losses for the Aussie if the White House goes ahead with the tariffs Friday but some local analysts say that, once all is said and done, the actual damage to China's economy under such a scenario would be quite small. Likewise for the Aussie economy too. 

"A tariff rate of 25% on all US imports from China has been our working assumption since September 2018 (see here). We do not expect a material impact on the Chinese, US or Australian economies if the US does increase the tariff rate on Friday. If the US government applies a blanket 25% tariff rate on all of Chinese exports to the US, we estimate the direct economic hit to Chinese GDP would be around 0.4%," says Elias Haddad, a strategist at Commonwealth Bank of Australia. "A hit of this magnitude can be easily offset with looser fiscal and/or monetary policy." 

Above: Pound-to-Australian-Dollar rate shown at 4-hour intervals.

The Pound-to-Australian-Dollar rate was 0.14% higher at 1.8630 during the noon session Thursday in spite of losses for Sterling against the major currencies. Westpac forecasts the GBP/AUD rate will remain around 1.87 until the end of June.

That is testament to the underperformance of the Aussie relative to everything else. The AUD/USD rate was -0.28% lower at 0.6971 and has fallen -2% in the last month. It's down -1.14% for the 2019 year-to-date. 

"Any week where JPY is the top G10 currency is unlikely to be supportive for AUD. Hence the retesting of post-flash crash lows in the mid-0.69s is in large part driven by poorer global risk appetite, seemingly thanks to the escalation of US-China trade tensions. This should be an ongoing source of instability in coming days," says Sean Callow, a strategist at Westpac. 

Above: AUD/USD rate shown at 4-hour intervals.

"AUD/USD is trading heavy around 0.6975 amid elevated US‑China trade tensions. There is a risk of further AUD volatility overnight when the RBA releases its Statement on Monetary Policy," says CBA's Haddad. "We think the risk exists because the post‑meeting statement gives an impression that hurdle to a rate cut has decreased. Any hints of a dovish outlook would likely increase pricing for a RBA rate cut and send AUD lower."

Trade-related headlines are a threat to the Aussie this week but the longer-term driver is the outlook for Reserve Bank of Australia interest rate policy, which could darken further on Friday. 

The RBA surprised the market Tuesday when it held Australia's cash rate steady at 1.5% rather than cutting it to a new record low of 1.25%, which provided an instant but short-lived boost to the Antipodean currency. 

However, the RBA's decision to leave its interest rate unchanged in May does not mean that a cut will not follow in June because it could well do and financial markets are unprepared for such a move that soon.

"The RBA’s steady hand at 1.5% surprised enough in the market to lift the overnight indexed swap curve well into 2020, with the terminal rate back above 1.00%. But markets still price a lot closer to 2 than 1 rate cut, with the RBA statement including lower growth and inflation forecasts," Westpac's Callow writes, in a note to clients Thursday.

Markets have bet heavily on RBA rate cuts ever since first-quarter inflation numbers surprised on the downside, further entrenching the Australian consumer price index beneath the 2% target amid a deteriorating global growth outlook and a slowdown in the domestic economy. 

Australia's Dollar may have been saved from further punishment by the RBA's steady hand on Tuesday but the Reserve Bank of New Zealand has since cut its own cash rate, which is an ominous sign for Aussie interest rate policy. 

The danger for the Aussie now is that a fresh escalation of U.S.-China trade tensions simply adds to RBA concerns over the outlook for the economy and ultimately forces an interest rate cut as soon as next month. 

Westpac and the market favour August for the first cut to the Australian cash rate so if the RBA's Friday statement suggests a move could come sooner then the Aussie would be left reeling and the Pound-to-Australian-Dollar rate helped onward to new highs. 

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