FX Comment – RBNZ douse rate cut speculation…remains dovish on NZD levels

by: Roy Teo

  • Domestic economy performing well—risks remain
  • RBNZ doused market speculation rate cuts are needed
  • NZD levels remain unjustified

Domestic economy performing well…

This morning, the Reserve Bank of New Zealand (RBNZ) governor Wheeler reinforced our view that the domestic economy is performing well and expects above average economic growth in New Zealand’s trading partners this year. The decline in oil prices is expected to boost household disposable income by around NZD 600 per household per annum if prices remain around USD 50 per barrel.

…risks remain

Nevertheless risks remain with uncertainty surrounding dairy prices, oil prices, house prices and the exchange rate. The decline in dairy farmer’s income is likely to be cushioned from last year’s record pay-out. However should dairy prices not recover as expected, household spending could slow more sharply. The dry weather in several dairy regions in New Zealand are also risks to farmers’ incomes. House price inflation is also increasing again in Auckland due to supply shortages.

Monetary policy on hold for now

Inflation is expected to be below the 1-3% target band and could be become negative for a period during 2015 due to direct and indirect impacts of falling oil prices filtering through the economy. Nevertheless, inflation is expected to rise towards 2% at a more gradual pace than previously anticipated. As such the RBNZ expects to keep the OCR on hold for some time. The RBNZ also laid out certain conditions that could warrant a rate cut. They include a deterioration in domestic demand, weaker than expected inflation due to drought or worsening external economic circumstances. The central bank doused recent market speculation that a rate cut is imminent due to lower headline inflation. This is consistent with our view that weak or negative headline inflation is not reflective of underlying cost pressures in the non-tradable sectors of the economy. The unemployment rate is declining, labor force participation is at record levels, business and consumer confidence surveys remain strong. Milk prices also recovered by 9.4% in this morning global dairy trade auction. We maintain our view that the RBNZ is likely to keep monetary policy unchanged this year before resuming its rate hike cycle in the second half of 2016.

NZD levels unjustified

RBNZ Wheeler reiterated that though the New Zealand dollar (NZD) has eased recently against its trade weighted basket of currencies, it remains unjustified and a further significant depreciation is expected. Short covering in the NZD from 0.72 to 0.74 in the past few days is not totally unexpected given the sharp sell off from 0.78 in the past two weeks. In our view, the current relief rally could extend to around 0.75 given that financial markets is still pricing in a small probability of a rate cut this year. The latter could be a hedge rather than a directional bet given the risks outlined by the RBNZ above. Looking ahead we expect the NZD to head lower towards 0.68 by the end of this year as the market is underestimating the timing and pace of rate hikes in the US in our view. Furthermore, we think that the RBNZ is likely to further intervene in the currency market to weaken the NZD should the exchange rate appreciate from current unjustified levels.