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Foreign Exchange

Government stealth war to weaken AUD

Benign inflation data has weighed on the AUD and is likely to kick-start the Reserve Bank of Australia’s easing cycle when it meets next month. However, the government’s “stealth war” against the currency could be of greater importance.

Australian core consumer price index came in at 2.15% for the first quarter, not just lower than expectations but below the 2.25% predicted by the RBA when it published its inflation forecasts in February. That has left investors debating whether to expect a 25 basis points or a 50bp interest rate cut from the bank when it meets on May 1.

However, Tom Levinson, FX strategist at ING, says of greater importance, and something not priced in by markets, is the prospect of a far deeper cycle of interest-rate reductions from the RBA brought about by tough fiscal austerity.

“In our view, the government appears intent on fighting a stealth war against AUD strength, with AUDUSD perhaps challenging $1.00 rather than $1.10 into mid-year,” he says.

“Even if this theory proves misplaced, the prospect of the government encroaching on the RBA’s independence can unnerve AUD.”

 AUDUSD vs RBA expectations

 
 Source: EcoWin, ING

Levinson believes the government of Australian prime minister Julia Gillard, who is under pressure – lagging in the opinion polls and facing an economy outside the resources sector that is struggling badly – is intent on retaining a forecast for a return to Budget surplus in the 2012/13 financial year.

Confirmation of that should come in its Budget announcement on May 8. Sticking to its pledge, however, will require the government to find A$20 billion in savings.

 Australian Budget balance outlook
 
 Source: treasury.gov.au

Levinson says should the government stick to its surplus estimate for FY2012/13, it will heap pressure on the RBA to cut interest rates – which stand at 4.25% – perhaps to 3% during the next year.

He says recent strong remarks from Gillard and finance minister Penny Wong, calling for the RBA to cut rates in the face of a slowing economy, are rather awkward, stepping on the toes of the independent central bank.

“However, this all looks to be part of a government plan,” says Levinson.

”Perhaps similar to Brazil, where authorities only managed to weaken the currency by finally tightening fiscal and loosening monetary policy, Australia’s politicians are ramping up efforts to weaken AUD, with fiscal austerity forcing through larger interest rate cuts.”

This article was first published by EuromoneyFXNews.

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