Economists at one of the major investment banks say the Australian dollar could fall as low as 73 US cents.

UBS economists Scott Haslem and George Tharenou say their application of a range of models suggests the Australian dollar could correct lower to between 73-83 US cents.

That is below their own forecast, which is for the dollar to be worth 85 US cents by mid-next year.

UBS say based on iron ore prices, the Australian dollar would be worth around 73 US cents, while a broader commodity prices basket would put a reasonable value around 82.

Using their own replica of the Reserve Bank’s ‘fair value’ model, the analysts say the Australian dollar should fall to 83 US cents.

A large part of the Australian dollar’s weakness is expected to be due to increasing US dollar strength.

Yesterday the Australian dollar broke convincingly below 90 US cents after the conclusion of the September US Federal Reserve meeting, which saw committee members lift their forecasts of where US rates would be by the end of next year.

The UBS economists say the story of rising US interest rates is likely to dominate currency trade in 2015.

“Most leading indicators suggest the US economy is strengthening relative to other countries, while diverging rates policies ought to be US dollar supportive,” they noted.

“Finally, the starting position of USD valuation is also favourable, with the real effective exchange rate close to a 40-year low.”

China weakness weighs on iron ore outlook

While that US economic strength pushes the greenback up, slowing Chinese economic growth is likely to weigh on the Australian dollar.

Many analysts are now forecasting Chinese growth in the low 7 per cent range this year, falling below 7 per cent next.

Shanghai steel futures fell more than 2 per cent to a record low, and iron ore futures are down around 3 per cent in China today, both of which bode ill for the future prices of Australia’s major export.

With slowing economic growth and a declining property market, many analysts are negative about the prospects of a sustained iron ore price rebound.

“There is no sign that demand for steel can improve in the short term,” China-based Cao Bo from Jinrui Futures told Reuters.

“I don’t think we’ve seen the worst for the iron ore and steel markets.”

Such weakness in iron ore prices is likely to heighten pressure on the Australian dollar to fall.

Interest rate implications

Saul Eslake says the recent drop in the local currency from the mid-90s to below 90 US cents shows the potential for a sustained drop in the currency to happen sooner rather than later.

That would implications for the timing of the first Reserve Bank interest rate increase.

“If this were to be the case we would likely bring forward our current forecast for the RBA to begin tightening policy from early 2016,” the Bank of America Merrill Lynch Australian chief economist wrote in a research note.

“We also note that, although any exchange rate depreciation is a net positive for the economy, it would not benefit all sectors equally. While export-exposed services sectors would be key beneficiaries, the retail sector would be amongst the big losers.”