Lehman Says Sell Australian Dollar Versus Yen on Growth Outlook

By Ron Harui

July 18 (Bloomberg) -- Investors should sell the Australian dollar against the yen on prospects economic growth will slow and the central bank will cut interest rates, according to Lehman Brothers Holdings Inc.

The local dollar may trim this year's 5.6 percent gain as the yield differential between two-year Australian and Japanese government debt narrowed for a fourth week after Reserve Bank of Australia Governor Glenn Stevens signaled borrowing costs are high enough to curb inflation. The currency, known as the Aussie, also may decline as prices of commodities the nation exports head for the largest weekly drop in almost four months.

``Yield spreads have been turning less Australian dollar positive, a trend that has been helped along by dovish comments from Stevens,'' analysts led by Jim McCormick, London-based global head of currency strategy at Lehman Brothers, the fourth- largest U.S. securities firm, wrote in a research note yesterday.

The Australian dollar traded at 103.19 yen as of 3:17 p.m. in Sydney from 102.95 yen in Asia yesterday. It reached 103.69 yen, the highest since June 26. The Aussie is the third-best performer among the 16 most-active currencies versus the yen this year. Lehman said it sold the Australian dollar at 103.03.

Australia's currency pared the past week's gain to 0.5 percent as the UBS Bloomberg Constant Maturity Commodity Index of 26 commodities headed for a 6 percent decline this week, the most since the week ended March 21, diminishing the outlook for the nation's economic growth. The economy expanded 0.6 percent, the least in almost two years in the first quarter, as consumers cut spending to pay higher mortgage, fuel and food costs.

`Increasingly Negative'

``The sharp drop in coal, energy and most metals prices means the Aussie-yen terms-of-trade dynamic is moving in the yen's favor,'' according to the Lehman report.

The rising terms of trade, a measure of income from exports, ``meant there remained considerable uncertainty about the outlook for demand and inflation,'' the Reserve Bank of Australia said in minutes of its July 1 meeting, which were released on July 15. Commodity prices influence the Australian dollar because raw materials account for 60 percent of Australia's exports.

``The story for Australia is increasingly negative,'' wrote McCormick and Steven Englander, a New York-based currency strategist at Lehman. ``The RBA will stay on hold until it starts cutting in 2009.''

A Credit Suisse Group index based on interest-rate swaps shows investors expect the RBA will cut its 7.25 percent benchmark interest rate by 11 basis points in the next 12 months. At the start of this week, the probability was for a 2 basis- point increase.

Spreads Support Aussie

The Bank of Japan is likely to keep interest rates unchanged this year at 0.5 percent, the lowest in the industrialized world, and will probably increase borrowing costs in 2009 because of accelerating inflation, according to Lehman.

A Japanese government report last month showed core consumer prices, which exclude fruit, fish and vegetables, climbed 1.5 percent in May from a year earlier, the fastest pace in a decade. The median estimate of 40 economists surveyed by Bloomberg News was for a 1.4 percent gain.

There is a 14 percent chance the Bank of Japan will raise its benchmark interest rate to 0.75 percent by the end of this year, according to calculations by JPMorgan Chase & Co. using interest-rate swaps.

The yield premium on two-year Australian government bonds over similar-maturity Japanese debt fell to 5.79 percentage points from 5.91 percentage points on July 11.

``Interest-rate differentials favor short Aussie-yen,'' the analysts said, referring to a trade where investors sell an asset in anticipation of making a profit by buying it back after its price has fallen. ``We short the Aussie against the yen as the latter still looks cheap.''

To contact the reporter on this story: Ron Harui in Singapore at rharui@bloomberg.net