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A major investment bank has said it thinks the Australian Dollar can continue its streak of outperformance.
Analysis from Rabobank shows that the Reserve Bank of Australia (RBA) will be a key component in furthering the Aussie Dollar's strength, prompting it to bring forward its forecast targets for the currency.
Rabobank thinks the RBA will raise interest rates twice this year, in August and November, as it battles stubborn domestic inflation.
"Most recent Australian economic data have cemented our expectations for further rate hikes this cycle," says Jane Foley, Senior FX Strategist at Rabobank.
She cites May retail sales growth at 0.6% m/m, which indicates solid consumer demand. Economists say strong consumer demand is a key driver of inflation.
The annual pace of CPI inflation slowed to 3.6% from 4.1% in the first quarter, thanks to base effects. This was above forecasts for an easing to 3.5%. For March alone, CPI rose 3.5% compared to the same month a year earlier, up from 3.4% in February.
A closely watched measure of core inflation, the trimmed mean, rose 1% in the first quarter, again above forecasts of 0.8%. The annual pace slowed to 4%, from 4.2%.
The government's decision to lower taxes for all 13.6 million Australian taxpayers from July 1 will not help fight inflation, as it will raise the economy's demand potential. The RBA has said the impact of the tax hikes poses an element of uncertainty.
The prospect of RBA interest rate hikes contrasts with expectations for rate cuts at other major central banks. This creates an interest rate differential that will support the Aussie Dollar.
"It is very clear that expectations around changes in interest rate differentials have been a huge driver across the foreign exchange market this year," says Foley.
Interest rate expectations are a primary driver of recent Australian Dollar outperformance, which has made it the best-performing currency in the G10 over the past month.
Rabobank maintains a target of AUD/USD 0.70, but brings it forward from a 9-month view to a 6-month forecast. AUD/USD is at 0.6753 at the time of writing.
"We see scope for a steeper move in EUR/AUD and hold a 6-month target of 1.51," says Foley. EUR/AUD is currently at 1.6040.
The Pound to Australian Dollar exchange rate is forecast to fall to 1.80 (from 1.90) on a six month view. (See how this compares to what over 30 other investment banks are predicting).