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Wednesday, 29 February 2012 05:57

Where to Next for AUD/USD May Depend on Incoming Retail Sales Data

Looking at the Australian dollar against the US dollar we see that the AUD/USD cross has been predominately consolidating over the last month after a very strong rally during January. What we're looking for now is a break of consolidation to either side, which should signify the next leg for this pair.

The two options then are an extension of the January rally, with a break of the consolidation pattern to the topside, and a move towards the 2011 highs near 1.1050, or a sharper correction to the rally over the previous 2 months, if price action breaks through our recent supports near 1.0625 and 1.0593. A third option would be for this pair to continue its sideways action, consolidating further prior to a break either way.

Will RBA Cut Rates Further This Year - Key Question/Factor for AUD

While the AUD is most primarily based on general risk sentiment - where equities and commodities go - and we have a very big sentiment event with the ECB LTRO 2 in Wednesday's trading session, we still want to keep our eye on the key fundamental releases which will be coming out of Australia in the upcoming Asian trading session - including most important one retail sales.

This report should help give us the most up-to-date view of the economy and what the RBA will be examining when it meets next to decide interest rates.

At their previous RBA meeting, the central bank surprised markets by holding steady at 4.25% instead of initiating another 25 basis point rate reduction. However, the concluding sentence of the statement said that the bank “judged that if demand conditions were to weaken materially, the inflation outlook would provide scope for a further easing in monetary policy.”

We'll have our chance to see demand conditions via the retail sales, new home sales, and private sector credit which are slated for release in the upcoming Asian session.

What To Watch For in Australia's Retail Sales Report

The key to look for from tonight's data is the retail sales report as it gives us the clearest indication of consumers spending.

As you can see in the chart above retail sales have been on a downward trend over the last six months and were negative in December. The consensus forecast is for a 0.3% increase in January.

If sales come in as expected it would break this downward trend in the indicator, and could give support to the RBA stance that interest rates are where they should be unless the economy deteriorates further.

A positive release in which retail sales are climb above 0.3% - say 0.5% or above - would only further hammer that theme home and could create the conditions for the Aussie to push towards its highs from the last two weeks (other risk events notwithstanding).

A negative release - one that undershoot expectations and shows either flat or negative sales in January would increase concerns about the wider economy and the prospects for consumer spending to drive growth in the early part of the year.

This would be a reason to increase pressure on the RBA to lower rates further and as a result would be a negative fundamental factor for the Australian dollar and on the face of it should weaken the Aussie from a fundamental interest-rate perspective.

Housing and Credit - Gauging Other Measures of Demand

While the retail sales release is the highlight in the batch of data released in the Wednesday Australian morning session, we can gleam important information from the 2 other reports we have on tap - new home sales and private sector credit growth.

New home sales - have been certainly rocky of late posting a negative 4.9% drop in sales in December after a rebound in November. Soft readings in this indicator means that households are not confident, or don't have the financial security to undertake such a big purchase.

This is an important measure of domestic demand then for us as economy and central bank watchers and the softer the housing market the more responsive the RBA should be. Another negative reading here would increase calls for lower interest rates from the RBA, while a bounce back into positive territory should be seen as a positive factor. However, we can see that Australia housing market is at a much lower pace than it was in the first half of 2011, and even small positive gains are not indicative of a healthy market.

Private credit data - the amount of new credit taken on by households - has been fairly consistent of late increasing 0.3% the previous two months, and 0.2% before that. The forecast for January is for a 0.3% increase and similarly to the retail sales and new home sales data we have talked about, private credit is a reading of overall domestic demand.

If private sector credit demand comes in above expectations - surprises to the topside - that would be a favorable fundamental condition for the Australian dollar while weaker demand for credit would imply softer overall demand and thereby pressure the RBA to lower rates further which can hurt the Australian dollar.

In the chart above we have a historical look at credit growth in annual terms and we can see that both housing and personal credit have been in decline over the past 2 years, as the housing market and economy have slowed - part of the problem the RBA is trying to address with its lower interest rates.

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