March 6 (Bloomberg) -- The Australian dollar will tumble 17 percent against the U.S. currency by year-end as an economic slowdown worsens and commodity prices drop, Morgan Stanley said.

The so-called Aussie will weaken this year to 53 U.S. cents, said Stewart Newnham, Morgan Stanley’s Hong Kong-based currency strategist. The economy unexpectedly shrank last quarter for the first time in eight years as exports slumped, increasing pressure on the central bank to resume cutting interest rates.

“We believe that the downward economic momentum is only likely to increase through 2009, given the severity of the global environment,” Newnham wrote in a research note yesterday. “Australia’s negative macro-dynamic will now take over as the main driver in pushing the Australian dollar lower.”

The Aussie lost about a fourth of its value against the dollar as the Reserve Bank of Australia cut interest rates by a total of four percentage points from September to February. Gross domestic product unexpectedly contracted 0.5 percent in the fourth quarter when economists had forecast 0.2 percent growth, a government report showed two days ago.

The trade surplus widened to A$970 million ($624 million) in January, less than the A$1.1 billion forecast, after exports shrank 5 percent with shipments of coal declining 19 percent. The current surplus will become a deficit of A$6 billion in 2009, Morgan Stanley said.

The Australian currency was unchanged at 64.29 cents as of 3:42 p.m. in Sydney from late in Asia yesterday.

‘Impaired’ Bank Assets

Australia’s dollar, which has dropped 35 percent since reaching a 25-year high in July, may weaken further as it becomes harder for the nation to service its external debt, which is 89 percent of GDP, Morgan Stanley said.

“We estimate that $287 billion of this external debt -- 34 percent of total external debt -- are short-term borrowings,” Newnham wrote in the report.

The nation’s banking system may weaken as assets are “impaired” by the downturn and its exposure to New Zealand, which entered a fifth quarter in recession, Morgan Stanley said.

Moody’s Investors Service lowered it outlook for three of Australia’s four biggest banks on March 2, citing concern over a slowing economy and rising bad debts. The ratings company cut to negative its outlook on Australia & New Zealand Banking Group, Commonwealth Bank of Australia and Westpac Banking Corp.

“The key challenges to our view are related to the China- stimulus effects and the heightened demand for gold if there is a global inflation scare,” Newnham wrote.

To contact the reporter on this story: Candice Zachariahs in Sydney at czachariahs2@bloomberg.net

Last Updated: March 5, 2009 23:48 EST