FX Flash – NZD gains as near term RBNZ rate cut odds decline

by: Roy Teo

NZD gains as near term RBNZ rate cut odds decline

The New Zealand dollar (NZD) strengthened by about 50 pips to almost 0.72 after Reserve Bank of New Zealand deputy governor Spencer emphasized concerns on growing imbalances in the housing market. As a result, the risk of a rate cut on 11 August declined modestly. More macro prudential tools including tightening loan to value ratios to counter strong investor demand is likely to be introduced by the end of this year. Limits on debt to income ratio could also be implemented though this has to be agreed by the Minister of Finance.

 

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Q2 CPI on 18 July crucial

Having said that, RBNZ Spencer said that inflation outlook will ultimately determine monetary policy. In June, the RBNZ had forecast that inflation in the second quarter will rise from 0.4% to 0.6% yoy as non-tradable inflation pick up from 1.6% to 1.9%. Food inflation (almost 20% of weight in CPI basket) remains weak. In addition, inflation expectations have been steady (1.64%) since the RBNZ last lowered the Official Cash Rate by 25bp to 2.25% earlier this year in March. However housing price (almost 25% weight in CPI basket) inflation has gained momentum in the second quarter, posing upside risk to RBNZ forecast that it will slow moderately. The NZD is also stronger than what the central bank had forecast last month. Hence there is downside risk to tradable inflation.

 

2016 year end NZD/USD forecast 0.70

Financial markets are pricing in more than 60% probability that the RBNZ will deliver a 25bp rate cut next month. We do not envy the RBNZ tough predicament as the NZD is likely to strengthen further if they fail to deliver next month. We stick to our view that the RBNZ is likely to lower the OCR next month, though a stronger than expected inflation print could delay the next easing till November. Our year end NZD/USD forecast is 0.70.