Soft GDP leaves the Aussie vulnerable

Months in advance, we could see that this would be a pivotal week for the Australian dollar and interest rates, as was early February. A month ago, the focus was on the RBA’s lower growth forecasts and its shift in underlying policy bias from an eventual hike to risks on the cash rate being more evenly balanced.
 

This week we saw another RBA policy statement and heard again from Governor Lowe in his enlightening speech on the housing market’s impact on the economy. But the pivotal moment was always going to be the release of Australia’s Q4 2018 national accounts. 

Many forecasters joined Westpac in looking for a weak 0.2%qtr rise in GDP, which was indeed the outcome. After a strong first half of 2018, the Australian economy slowed sharply in the second half, to be up just 2.3% over the year to December. There was also considerable (and justifiable) media attention on the consecutive quarters of contraction in GDP per person.

So while headline growth was close to consensus, there was plenty to worry about, including for the RBA which said after this week’s Board meeting that its “central scenario is still for the Australian economy to grow by around 3 per cent this year.”

Westpac expects that by the time of its August quarterly statement, the RBA will be forecasting GDP growth of below the 2.75% trend pace and thus will deliver the first of 2 cash rate cuts this year. After the GDP report, some other forecasters joined in the rate cut chorus and interest rate markets scrambled to fully price in a rate cut by November, with a 50% chance of another by early 2020.

This was obviously another setback for the Aussie dollar, which fell to 2 month lows just above 70 cents. But we did see some positive data as well. Australia’s trade surplus in January of $4.5bn was the second largest on record, with the December surplus the third largest. Exports are up 16% over the year and the current account deficit is just 1.5% of GDP, compared to a 30 year average of a 4.2% deficit. In this context, we might wonder how much the progress of US-China trade talks will really matter for the Aussie.

But while Australia’s stronger trade position lends background support to the currency, the soft GDP report will reverberate for some time. Weak retail sales growth in January reinforced worries about the Australian consumer.

So the Aussie could remain under pressure against the US dollar from RBA rate cut talk for some time, though in the week ahead, the updates on business confidence and consumer sentiment are unlikely to have a large impact on the currency. 

We should note that the Aussie is actually higher this week against the euro and the Canadian dollar, after the European Central Bank and Bank of Canada turned more dovish to reflect weaker economic growth. So the RBA is not alone. We’ll speak to you next week.