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China could cut short rally in Aussie dollar

Fan of one hundred dollar Australian banknotes.
Linda Hides | E+ | Getty Images
Fan of one hundred dollar Australian banknotes.

The Aussie dollar has enjoyed a strong run over the past two months, but some analysts believe the re-emergence of fears over China could cut the rally short.

"The Aussie [has] probably done its dash for the meantime... the stuff going on in China is starting to impact the Aussie and bring it down now," said Richard Yetsenga, head of global markets research at ANZ bank.

The commodity-linked currency has rallied over 7 percent since the start of September on signs of a pickup in China, Australia's largest trading partner, coupled with weakness in the U.S. dollar as expectations for tapering by the Federal Reserve were pushed out until next year.

(Read more: The rally from down under – are Aussie stocks unstoppable?)

However, the trend appeared to falter last week when the Aussie pulled back from a high of US$0.9758 hit on Wednesday following Australia's stronger-than-expected inflation data released Tuesday.

ANZ's Yetsenga said the Aussie at US$0.95 to US$0.97 is too high, and levels of US$0.90-US$0.91 would reflect fairer value.

"China is gradually moderating still. Even though you've had a mini-growth stabilization in the last couple of months, you can't really see any meaningful signs of pickup in the things that matter like commodity prices or imports for instance," he said.

China's gross domestic product grew 7.8 percent in the third quarter, higher than the first quarter's 7.7 percent and the second quarter's 7.5 percent, prompting some hope that the economy is picking up again.

(Read more: Why the Aussie is a 'screaming buy': Economist)

Yetsenga urged investors to be cautious on China, however, especially considering the country's ongoing structural issues, which were evident again last week when China's seven-day repo rate, which is seen as gauge of confidence to lend in the interbank market, spiked and sent jitters through global markets.

"Of course the tightness in money market rates continues to highlight that there needs to be a significant amount of financial structural adjustment in China, so I think you need to be cautious," he said.

Other analysts told CNBC it was too early to start becoming bearish on the Aussie, however. Keagan York, head of FX strategy at Compass Global Markets, said he saw last week's pullback bottoming out at around US$0.9550.

"The end of the idea of tapering and the solid footing that the local economy brings should see Australian dollar back towards and just short of parity before year end," said York.

(Read more: Australia lifts debt ceiling - no shutdown required)

Meanwhile, Mitul Kotecha, head of global FX Strategy at Credit Agricole, said he has been bullish on the Aussie in recent months but has recently turned more cautious.

"I don't see it pulling back to the US$0.90-US$0.91 level, but I do think upside might be limited. The market has already discounted the better Chinese data, plus the market has previously been short the Aussie and is now more neutral," he said.

(Watch this: Downside of Australia's thriving property market)

Kotecha said another important factor for the currency will be the reaction of the Reserve Bank of Australia to recent strength, given its previous moves to keep the Aussie low through interest rate cuts.

The central bank is due to meet next week, and Kotecha said he doubted the Reserve Bank of Australia would raise rates from the current level of 2.5 percent, but could use dovish rhetoric to introduce some downward pressure.

(Read more: How are you trading the dollar index?)

Greg Gibbs, senior FX strategist at RBS, said the combination of signs of slowing demand from China and the greenback's weakening trend should keep the currency trading between US$0.95-US$0.9750.

The Aussie was trading at US$0.9601 in mid-afternoon trading in Asia on Monday.

—By CNBC's Katie Holliday: Follow her on Twitter @hollidaykatie

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