FX | Economy
FX Focus - EURAUD – Rate Dynamics Likely To Shift Against The Euro
Posted on| Forecast | Spot | 0 - 3m | 6 - 12m | Long-term |
|---|---|---|---|---|
| EURAUD | 1.64755 | 1.6420 | 1.5940 | 1.5790 |
*Forecasts as of March 2024.
- Markets now expect the European Central Bank (ECB) to be the first major G10 central bank to cut rates and by the most, pricing ~95bp in cuts to the end of 2024 versus ~60bp for the Federal Reserve (Fed) and just 35bp for the Reserve Bank of Australia (RBA). The ECB’s April meeting this week therefore is likely to see easing actively discussed for the first time, but with a cut likely at the June meeting. Reaching at least a 3% deposit facility rate from the current 4.0% seems uncontroversial as the ECB shifts from insurance against inflation entrenchment to insurance against recession risks. The ECB now also seems to be not in the mood to wait for the Fed either.
- This is because inflation in the euro area is falling faster than in the US and Australia. The latest Eurostat flash estimate of euro area headline inflation shows a softening from 2.6% YY in February to a 32-month low of 2.4% YY in March. Meanwhile, core inflation has also moderated from 3.1% YY in February to a 25-month low of 2.9% YY in March. Looking at the short-term dynamics of euro area inflation, there now looks to be a clear path to normalization with inflation likely averaging 1.4% halfway through H1’2024,. Separately, the ECB survey of consumer inflation expectations conducted in February shows that for the next 12 months, households expect the 12-month change in CPI inflation to be 3.1% YY, the lowest level since 2021, down from 3.3% YY in January.
- In contrast, the RBA looks poised to cut rates much later and by a lot less due to sticky services inflation. February inflation data shows Australia’s monthly headline CPI unchanged at 3.4% YoY for three consecutive months with sticky services inflation the key driver while goods prices also rise after a fall in January. The only way inflation in Australia is likely to return to an easing path is for domestic demand to moderate which looks unlikely near term given the very tight domestic labor market that boasts an unemployment rate of 3.7%, a record low never seen before. Citi Research expect the RBA to cut just 25bp this year in November, if at all (markets are discounting 35bp) and the ECB to cut 125bp commencing in June (markets are discounting 95bp), leaving rate differentials to widen significantly in favor of AUD vs EUR during H2’24.
- Externally though, AUD faces headwinds from 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 also point to a potentially quick rebound if China posts strong credit prints for February and March while Chinese inventories should commence drawing down by late March/April. Overall, Australia’s economy remains relatively resilient compared to its G10 peers accompanied by a comparatively less restrictive monetary policy stance by the RBA versus its peers though with some near-term external headwinds caused by declining iron ore prices. But rate differentials are likely to gradually widen in favor of AUD as the ECB cuts earlier and more sharply while the RBA stays put until November (or through 2024) and the possibility of iron ore prices rebounding mid-year and during H2’24 as China’s inventories draw down, would likely add an external kicker to AUD against EUR.
EURAUD Looks To Be Peaking
Source: Bloomberg, April 6, 2024
