Chart of the week: The Australian dollar still needs to ‘Mind the Gap’ on interest rates

5 June 2017

Bob Cunneen, Senior Economist and Portfolio Specialist

                   Australian dollar vs interest rate gap

                  Sources:  Reserve Bank of Australia and Federal Reserve Bank of St. Louis.

The Australian dollar (AUD) has been surprisingly resilient against the US dollar (blue line) for the past financial year. The AUD has managed to trade in a narrow range between 0.73 and 0.81 cents. For a currency which is sometimes known as the Pacific Peso, this has been a remarkably stable performance.

Currently Australia’s cash interest rate is only 1.5% compared to the equivalent US Federal Funds rate at 1.88%. Effectively, Australia’s cash rate is only marginally below the US with a negative interest rate gap of -0.38% (red line).

However the AUD is likely to come under pressure over the coming months. The US Federal Reserve (Fed) provided guidance at its June meeting that “further gradual” increases in US interest rates should be expected. The Fed projects another two interest rate increases totalling 0.5% this year. By contrast, the Reserve Bank of Australia seems stuck in neutral with no guidance for any move in interest rates. With the Fed raising US interest rates, the interest rate gap could move towards -1% by the end of 2018 (green arrow). So this interest rate gap is set to become an even larger chasm for the AUD to navigate.

Source :Nab assetmanagement 5 July 2018 

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