Interest rates may fall below US rates in 2017 — will the AUD slump?

NAB analysts say 2017 may be the year the Reserve Bank cash rate falls below US interest rates, and the last time this occurred the Australian dollar slumped as low as 48 US cents.

There has only been one period in the last 25 years when the RBA has been lower than the US Fed — during the period 1997-2001 when the Australian dollar was buying between 48 and 74 US cents.

But, NAB said it doubted the Australian dollar would drop much below 65 US cents, other than in the midst of a US-instigated trade war — something critics of President-elect Donald Trump's policies say he risks doing.

"A lot has to go wrong in Australia, alongside unrelenting US dollar strength, if AUD/USD is to come close to re-running its late 1990s-2001 experience," wrote Ray Attrill, global co-head of FX Strategy at NAB in a research note.

"The terms of trade currently sits some 40 per cent above the average level that prevailed in 1997-2001, implying a significant higher equilibrium level for the AUD."

NAB noted AUD weakness in the earlier period occurred prior to Australia's China-driven positive terms of trade shock and the subsequent resources boom.

At that time the AUD weakness was compounded by the introduction of the GST in July 2000, with GDP flat in the third quarter of 2000, and falling 0.3 per cent in the fourth quarter.

The United States during that period was also experiencing the dotcom boom, with the US attracting more capital into private sector corporate securities than US government and agency debt, and capital flooding the country independent of interest rate considerations, NAB noted.

There are fewer than 100 basis points separating the Reserve Bank's rate of 1.5 per cent and the US Federal rate of 0.75 per cent, meaning two cuts from the RBA and two hikes from the Fed next year or another similar scenario, would see local rates lower.

"One thing we know for sure is that the RBA will not be cutting rates by 200bps [basis points] in 2016, albeit a flirtation with unconventional monetary policy comes onto the radar if circumstances dictate a cut to 1 per cent," Mr Attrill said.