This sharp decline in the Australian dollar may significantly delay RBA rate cuts, due to its inflationary impact.

The Australian dollar, along with most other currencies and the major commodities, has fallen badly over the last three weeks against the US dollar. It seems we are experiencing a sell anything that benefited from prior US dollar weakness theme. This is a massive squaring up of every long bet in any market that was held against the US dollar. Perhaps there is a story behind the scenes that we may one day discover, but in dealing with markets at the moment, there is no sense standing in front of a freight train. It is a question of momentum.

All these markets are now severely oversold and experiencing some of their biggest moves in quite some time. When these markets finally exhaust this down move, perhaps today or a week from today, it will leave a situation where virtually no one is long commodities or non-USD currencies. At that point we will see a bounce, or even sustained rallies again, that will perhaps be just as spectacular.

In the case of the Australian dollar, personally I thought the low would be 95 cents, and today we are edging toward what could be major support near .8950.

RBA rate cut expectations have been a major component of this currency collapse. My view remains that the market has got ahead of itself, and that the RBA will wait until November or December. When we now add the inflationary impact of a currency that has fallen 9% in just three weeks, then it is very likely indeed that the RBA will be in no hurry to let this inflationary impact get out of the bag. The RBA will maintain rhetoric about the domestic slow down, but given the added impetus to exports provided by this lower currency level, and higher cost of imports, the RBA is likely to stay on hold until December.

For the very reason the AUD has been hard hit, the fear of rate cuts, its fall may preclude such action by the RBA for some time.

If we get a situation in the next week where the AUD sellers have exhausted themselves, and start to see a recovery in commodities and other currencies, the rollercoaster pressure may return to the upside with force. It is interesting to note that in August last year the Australian dollar fell 10 cents from .8665 to .7675, over just seven trading days. It then rallied by year end to 94 cents. A similar repeat would have the AUD still sailing well clear of parity by year end. The Australian dollar is down but not out.

My forecast since 76 cents in mid 2006 has been for the Australian dollar to achieve parity in 2008. While those who derided that forecast joined the same view belatedly at about 96 cents, it now looks a distant possibility for all of us to get that one right. Nevertheless it cannot be completed discounted as a possibility, especially if the RBA remains on hold until year end. I suspect we will see a low near 89 cents followed by a recovery toward 95 cents, which may contain for this year, though I will stick with the parity forecast for the moment just to highlight that after an 8 cent fall, there may be more risk to the upside than the downside from here.