Ord Minnett now believes the Australian dollar will reach US$0.70 by the end of 2016 and US$0.67 by March 2017.
From the Reserve Bank of Australia’s perspective, a lower currency is imperative. A weaker dollar allows the possibility of, firstly, stabilising domestic inflation; secondly, a higher rate of inflation for imported goods and services through the currency; and lastly, additional output growth from the currency-sensitive sectors of the economy.
To be fair, we always had less bullish expectations for the Australian dollar in the second half of 2016 as the combination of a correction in commodity prices, a resumption of the US Federal Reserve tightening cycle, and a moderation in Chinese growth, came into play.
Our forecast is for the terms of trade should move modestly lower and then sideways from here, suggesting commodity prices are no longer the anchor for a lower currency to the extent that we have seen in recent years.
Instead, the currency will be more influenced by the difference between the cash rates set by the RBA and overseas central banks.
Our forecasts envisage only one more round of balance sheet expansion from the European Central Bank and the Bank of Japan (as well as another cut to the deposit rate from the Bank of Japan) and 100 basis points of tightening from the US Federal Reserve by mid-2017, but the risks are clearly biased towards more dovish outcomes if history is any guide.
The other risk for the currency remains inflows from investors that are targeting higher yields from longer-duration investments. A lower cash rate here will drag yields lower across the yield curve, but it will still leave Australian yields above developed economy peers.
Furthermore, other assets in Australia still offer relatively attractive yields, e.g. bank dividend yield are around 6% and commercial property yields are around 5-7%.