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The NAB is the latest bank to sharply upgrade its Australian dollar forecasts

David Scutt

Unless sentiment towards the US dollar starts to turn, or commodity prices begin to weaken, the Australian dollar is likely to remain well supported for the remainder of the year. And that means previous expectations for significant broad-based weakness are unlikely to eventuate.

That's the view of the National Australia Bank's (NAB) FX strategy team who, like many others, has decided to revise up its Australian dollar forecasts today.

"Having held our nerve through the first seven months of 2017 with our long-standing call for the AUD/USD to fall to 70 cents by the end of this year, the ever-diminishing prospects for a significant near-term recovery in the US dollar now forces us to acknowledge that it is now difficult to expect such a steep fall this year," the bank wrote in a note today.

Here's the NAB's updated forecasts, both against the US dollar and major crosses.

Against the greenback, the NAB now sees the Aussie trading at 75 cents by the end of year, above its previous forecast for a larger drop to 70 cents.

And, longer-term, it doesn't see much further weakness arriving over the next couple of years, forecasting that the AUD/USD will bottom at 73 cents next year before rebounding modestly in 2019.

The NAB says this largely reflects the US dollar side of the AUD/USD equation.

"The long and the short of our forecast revisions is the limited prospects for an early reversal of the now 9.5% fall in the US dollar since the start of the year," it says.

"A Fed rate rise in December would go some way to eliciting a short-covering rally, but this alone would be unlikely to reverse more than a few percent of the January decline to date. Much more than this is likely to require clear evidence of a functioning US government fully engaged with Congress on tax and other fiscal and regulatory reform measures.

"At this juncture, that’s far too heroic an assumption to build into our central-case forecasts."

And while the US dollar appears unlikely to garner much support in the near-term, the NAB says that Aussie is being powered by continued strength in commodity prices, more than offsetting any drag created by lower interest rate differentials between the Australia and and the US.

This chart from the NAB shows the change in its short-term fair-value AUD/USD model this year by individual component.

Thanks largely to booming commodity prices, the NAB's model suggests that fair value for the AUD/USD is now around 77 cents, not far off the 79 cent level where it currently trades.

"The absence of a large-scale overvaluation at present is also limiting our appetite for continuing to expect a big fall in the coming few months at least," it says.

However, while that lack of overvaluation is one of the main factors underpinning its updated Aussie dollar forecasts, the NAB still expects that it will weaken modestly next year due to higher US interest rates and renewed headwinds for commodity prices.

"Our base line view is that the Fed will do more than markets currently expect next year, that some form of tax reform deal will get done and that commodity prices will be getting less support from Chinese demand than has been the case for much of 2016 and 2017 post the 5-year National People’s Congress (NPC)," it says.

"If so, and with the RBA seen on hold through H1 2018 at least, the very real prospect of rates cross-over next year carries with it significant downside AUD risk."