The Aussie's drop isn't done yet

The Australian dollar has lost 30 per cent of its value in the past six months but even if the RBA doesn't cut today, the outlook for the currency remains bearish.

Last week was another grim week for the Australian dollar. The rumour mill ran amok with investors dumping the local unit on expectations of a deteriorating monetary policy outlook, sparking concern and leading markets to questions whether the currency can consolidate.

All eyes on the RBA

The Reserve Bank’s first rates decision after the January sojourn will be closely watched, and will likely send the Aussie tumbling further if the RBA cuts.

Over the past six months, the Australian dollar has suffered its largest drop since the global financial crisis, losing 18 per cent against the US dollar. From its peak against the US dollar in July 2011, when it passed $US1.10, the Aussie has lost 30 per cent of its value. 

For the first time in 18 months the market has priced in a better than 50 per cent chance policymakers will reduce interest rates. The dovish shift in RBA policy has been well publicised, with governor Glenn Stevens and his board members regularly proffering comments to suggest a period of instability lies ahead.

Governor Stevens has made it abundantly clear he would prefer to see the currency trading at US75c to ensure a balance across the economy and cushion the decline across the mining sector.

Soft US data offers relief

The Australian dollar did, however, find some respite in a softer-than-anticipated US fourth quarter GDP report. The US economy expanded just 2.6 per cent in the three months to December last year, a read well below analysts’ expectations and a considerable retraction on the 5 per cent growth enjoyed in the third quarter of 2014.

This weaker-than-estimated reading puts pressure on interest rate expectations and raises questions surrounding the strength of the overall US economic recovery. 

US data flows were mixed throughout the fourth quarter of last year, opening the door for suggestions that economists have overestimated the strength of the world’s largest economy. Still, the divergence in monetary policy will lend support to the greenback throughout the months ahead as Europe and Japan struggle to fight deflation.

The inflation question

With the subsequent risks of a further sell-off triggered by a cut or even change in stance, Australia's CPI growth may well hold the key. It has slowed to 1.7 per cent (its lowest level since mid-2011) and policymakers will need to identify the reasons for subdued inflation.

But with the rapid depreciation of the Aussie dollar through 2015, and inflation well inside the RBA’s target band, it’s doubtful policymakers would intervene at this point. Instead, they will likely monitor global growth conditions, falling commodity prices and a slowing Chinese economy.

So what's next? If the RBA refrains from cutting rates this week, we could see a possible short-term bounce on the Australian dollar. However the medium-to-long term forecast remains bearish, with calls for US75c and below a real possibility come mid-year.

Matt Richardson is Corporate Foreign Exchange Dealer at OzForex, a global supplier of online international payment services and a key provider of Forex news. OzForex Group Limited is a publicly listed entity with shares traded on the Australian Securities Exchange under the code "OFX".

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