FX Focus - GBPAUD – Scales Are In Favor Of The More Resilient Economy

At its March meeting, the Bank of England (BoE) appeared to be leaning more dovish in the voting breakdown that showed one member continuing to vote for a 25bp rate cut, while the two dissenters who had voted for a rate hike in February now joined the majority voting for no change. While the policy statement contained minimal changes, it nevertheless tilted in a more dovish direction. Notably, the BoE Monetary Policy Committee (MPC) acknowledged a more material impact from higher frequency indicators showing disinflationary tendencies. Additionally, the Minutes of the meeting indicated the MPC “would continue to consider the degree of restrictiveness of policy at each meeting”. The MPC’s reference to policy bearing down on inflation, as well as slack was also re-iterated which creates potential for a more forward-looking view on wage growth.
 

The implication here is that rate cuts could still leave policy restrictive and that the bar towards cutting rates is now significantly lower. It could also suggest a potentially faster rate cut cycle as pressure on the UK labor market spills over into a sharper underperformance from the UK economy than is currently the case. Much however will depend on the trajectory of UK inflation forecasts in BoE’s May Monetary Policy Report (containing an updated quarterly forecast round) and would probably require UK inflation to fall below the 2% BoE target and/or unexpected economic weakness materializing for the BoE to commence its rate cut cycle in earnest.
 

Current UK rates pricing discounts ~50bp in BoE cuts to 2024-end with the first 25bp cut expected at BoE’s August 1st meeting. The risk is for deeper and faster rate cuts as the UK economy underperforms its peers. In contrast, the RBA looks poised to cut rates much later and by a lot less given the much tighter Australian labor market (with an unemployment rate at a record low of 3.7% and still strong momentum versus 3.9% for the UK with weakening momentum). Australian market rates discount just 30bp in RBA rate cuts to 2024-end with the first cut likely seen in November (vs August 1st for BoE). The risk is that RBA rate cuts get pushed out to 2025. 
 

Externally though, AUD faces headwinds from a deterioration in its terms of trade via declining iron ore prices (Australia’s key commodity export to China) which has sold off more than 25% this year though the Citi Commodities Strategy team point to a potentially quick rebound if China posts strong credit prints for February and March while Chinese inventories are likely to commence drawing down by late March/April.
 

Overall, Australia’s domestic economy remains relatively resilient compared to the UK but with some near-term external headwinds caused by declining iron ore prices. However, with the BoE expected to cut rates by more and at a faster pace than the RBA, rate differentials are likely to gradually narrow in favor of AUD during H2’2024. The possibility of iron ore prices stabilizing and rebounding during H2’24 (as China’s inventories draw down), could add an external kicker to AUD against GBP.