The specter of further rate cuts from Australia’s central bank has taken the wind out of the sails of a robust Australian dollar, which hit a one-month low on Tuesday. Yet the commodity currency is unlikely to go into free-fall and its losses should be limited to 3 percent this year, experts say.
The Aussie dollar fell just over 0.5 percent to 1.0292 to the U.S. dollar after the Reserve Bank of Australia (RBA) cut its benchmark interest rate by 25 basis points to 3.25 percent, its lowest level in three years, citing the slowdown in top trading partner China, falling prices of key commodity exports and a high exchange rate.
It is down 3 percent from a high above 1.06 to the U.S. dollar hit last month and is likely to weaken to 1.02 within the next month, before heading to parity by the end of the year, say foreign exchange strategists.
The currency last fell below parity in June, dragged down by worries over the outlook for the euro zone.
However, strong demand for Australian government bonds alongside central bank action in the West, which has been positive for risk sentiment, will prevent a steep downswing in the currency, said Sean Callow, senior currency strategist at Westpac Bank.
“The rate cut will take a bit of heat out of the Aussie, but I wouldn’t be too aggressive in my outlook for the currency with QE3, and the reduced risk out of Europe limiting losses,” he said, referring to the third round of quantitative easing unveiled by the U.S. Federal Reserve last month.
In addition, Greg Gibbs, foreign-exchange strategist at RBS, noted that the market has already priced in multiple rate cuts, so further easing will not come as a surprise.
“This may suggest that the Australian dollar may not fall that much further. But you would definitely be sliding the Aussie down the list of currencies to own,” Gibbs said.
The Australian dollar, which has tended to track moves in commodity prices, has defied a fall in commodity prices this year, rising sharply as investors view Australian assets as a safe-haven from uncertainty in the world.
It gained roughly 10 percent between early June and mid-September, before edging down.
Any further pull back in the Australian currency is likely to be welcomed in Australia where mining is a key driver to the economy.
Weaker commodity prices without the depreciation of the Aussie dollar hurt the income of mining companies, whose products are largely priced in U.S. dollars, resulting in weaker national income growth.
The RBA warned on Tuesday mining investment would peak earlier than expected in 2013 and at a lower level than previously thought.
It is widely expected to cut rates once more before the end of the year, with the interest rates futures market currently pricing in an 80 percent chance of a 25 basis point cut in November.
“The fact the RBA has made it clear that a tapering in the resources investment boom next year is a factor to which they are willing to respond to now, suggests they should be happy to cut again,” Ray Attrill, co-head of foreign-exchange strategy at National Australia Bank, said.
—By CNBC’s Ansuya Harjani