The Australian, New Zealand dollar

The resilient data from Australia seems to be bucking the global trend and is helping to boost the currency's profile. However, some of the rise versus the American dollar has also been a reflection of the USD weakness and poor US data, and not just the strength of the AUD. It is therefore not surprising that the New Zealand dollar (NZD) has also made gains against the USD. As has been the case since June last year, the ebbs and flows of risk aversion have been key to both AUD and NZD, and this is likely to continue for the foreseeable future.

The data from Australia has been consistently strong for some time now, and it is no surprise. Economic growth has been steady and the Royal Bank of Australia (RBA) sees inflation at above the upper limit of its target band (three per cent year-on-year) in the first half of this year, suggesting that there is a clear case for tightening. There has also been strength in building approvals and retail sales. With the data outperforming expectations, this further suggests that, for the moment, the domestic economy remains largely unaffected by the pressures facing some of the other G10 economies.

It is envisaged that the RBA will only be able to avoid an interest rate hike at the next meeting on February 5 if market interest rates remain elevated compared to the cash rate. However, even if the RBA keeps rates unchanged at the next meeting, the tone of the latest RBA meeting minutes and the balance of data continuing to be released suggest that the cash target rate will be raised to seven per cent over the next few months.

It is also worth remembering that 2008 will see the implementation of new policies from the recently appointed Labour government, including universal tax cuts scheduled for this year. This fiscal looseness may drive the economy further forward and give the RBA even more reason to push rates higher as the year progresses.

For New Zealand, the fundamental picture, although healthy, does not look quite so robust. Recent data has shown the current account deficit widening considerably, giving the Royal Bank of New Zealand (RBNZ) further cause for concern over the strength of the NZD. When compared to the AUD current account deficit, the relative difference is quite significant, and although AUD may still be at risk, for the moment it is New Zealand that is suffering the most on an external front. With the economy reliant on exports and tourism for a large part of its growth, a stronger currency and weakening global growth outlook endanger further progress. The potential problems caused by the strength of the NZD should ensure that the RBNZ leaves interest rates unchanged at 8.25 per cent for some time.

Since AUD-NZD peaked for the year at just over 1.20, the pair have come down fairly dramatically, partly a function of Australia's problems with its domestic short-term money market, which were elevated during the second half of 2007.

Normally, rising AUD yields in terms of three month money have pushed the currency higher, but when interest rates jumped suddenly higher, suggesting a crisis, the AUD suffered.

Since the end of November, however, the short money rates have started to come back to more reasonable levels and, as the market has normalised, the AUD has pulled back against the NZD, something we feel could be set to continue.

However, given Australia's economic strength, we feel that the AUD may present a good relative opportunity against NZD.

With Australian target rates likely to head higher through the year and the RBNZ on hold, the narrowing yield premium will give at least some support to the AUD against its neighbour. The AUD's fundamental story is healthier with the domestic economy remaining buoyant and external imbalances less of a problem.

This report was compiled by the Marketing Department of HSBC Bank Malta plc on the basis of economic research and financial information produced by HSBC International Bank.