Australian dollar faces headwinds, but Chinese bounce-back should shelter AUD from major declines

The Australian dollar has continued its correction on the global currency markets today.

"Over the last few weeks, economic reports suggest that Australian economic growth may be ebbing below trend, struggling under the weight of its historically expensive exchange rate," says an exchange rate note from RBS. 

Australian trade figures were much weaker than expected in January, showing a sharp fall into deficit (-0.6%of GDP), wider than that experienced after the floods in early 2010 ,limited coal production.

This result was mirrored in other countries, such as Japan, and reflected distortion in Chinese imports around the timing of the Lunar New Year.

RBS note that Chinese commodity import data rebounded in February and thus analysts at the bank say we should expect the Australian trade balance return to a solid surplus.

Nevertheless, there is reason to think the trade balance may have peaked due to strong import demand and lower commodity prices.

The key event for the Australian dollar, going forward, is the next RBA interest rate decision due in April.

There are no big releases before the next RBA meeting on 3 April, it may wait to see jobs data on 12 April and CPI inflation on 24 April before
considering cutting in May.

But on the current trajectory in partial data, coming off a modest Q4 GDP outcome, a couple of 25bp cuts before mid-year are likely. The government remains focussed on returning the budget to surplus, adding to the case for lower rates.

The market is pricing 30% odds of a cut next month, a little more than one cut by mid-year and 50bp over the year ahead. So the market is somewhat prepared.

Nevertheless, ongoing speculation about cuts should restrain upside in the AUD in the near term.

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