Rate hike puts the Aussie on track for strong gains in 2010

THE fact that the Reserve Bank of Australia (RBA) hiked interest rates by 25 basis points to 4.25 per cent yesterday will not have come as much of a surprise to currency traders – a move either this month or next was widely anticipated and given that the May meeting falls just days before the Australian budget, the odds were firmly in favour of an April hike.

But what will have surprised the markets was the hawkish tone of the central bank. Its governor, Glenn Stevens, said in the statement accompanying the decision: “With growth likely to be around trend and inflation close to target over the coming year, it is appropriate for interest rates to be closer to average.” Stevens also noted that strong growth in Asia had contributed to pressure on prices for raw materials. Analysts said that the change in the RBA’s language – Stevens had also made several hawkish comments ahead of the April meeting – suggests more tightening is on the way.

With the central bank signalling further rises in the benchmark rate are ahead, it is no wonder that institutional investors such as Pimco and BlackRock are bullish on the Australian dollar. Recent data from the Commodity Futures Trading Commission (CFTC) shows that more futures traders are betting on the Aussie gaining against the US dollar than at any time since June 2007.

The Australian dollar is now trading around US$0.92 and is heading back towards the 17 March high of US$0.9250. A number of banks, including Standard Chartered and HSBC, are forecasting that the Aussie dollar will hit parity with the greenback. However, others, such as JPMorgan and RBS have trimmed their expectations and no longer anticipate that the commodity currency will reach parity this year. Technically, the market is targeting the resistance area of US$0.9245-50 but breaking through may prove difficult – the Aussie has never risen to parity with the dollar since it floated in 1983 and has struggled every time it has approached this level.

Although forecasts for a strong US dollar and worries about Chinese tightening may cap any rise in the Aussie against the greenback, there are still plenty of reasons to expect further moves northward in other Aussie currency pairs.

“With rate hikes in Australia driven by a normalisation process rather than the economic data flow, the Australian dollar is expected to outperform its commodity currency peers in the near-term,” says BNP Paribas’ senior currency strategist Ian Stannard. He reckons that the euro-Australian dollar pair will come under pressure in the current environment with the break below the A$1.4585 lows triggering a decline towards the A$1.40 area.

And against the New Zealand dollar, he says that the Aussie has broken sharply higher through a major resistance level and the Kiwi is expected to underperform as the country’s economic data disappoints. Its central bank deliberately remains behind the curve to reduce the attractiveness of the Kiwi as a carry currency. The target is initially for Aussie-Kiwi at NZ$1.3355 and then at NZ$1.35.

Carry traders will also be looking to capitalise on the widening interest rate yield differential between the Australian dollar and the Japanese yen. The Australian central bank is continuing to appear hawkish while the dovish Bank of Japan is forecast to keep its target rate at 0.1 per cent for at least the rest of this year and it has been mulling further expansionary policies.

So while the Aussie’s fortunes against the US dollar may be looking mixed, foreign exchange traders looking to make profits out of the Australian dollar should look more closely at trading it against the euro, the New Zealand dollar and the Japanese yen.