FX Flash – Rate cut fears weigh on NZD

by: Roy Teo

RBNZ hints more rate cuts likely…

This morning the Reserve Bank of New Zealand (RBNZ) said that while domestic growth is expected to remain supported by strong inward migration, construction activity and tourism; low dairy prices are depressing incomes in the dairy sector and weighing on farm spending and investment. The outlook for inflation has weakened since June and it seems likely that further policy easing will be required to ensure that future average inflation settles near the middle of the target range. Excessive house price inflation is likely to be addressed via stronger macro-prudential measures.

 

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…and a decline in the NZD is needed

On the exchange rate, the RBNZ was dovish, as expected. The current level in the NZD trade weighted index (TWI) is 6% higher than assumed in the June monetary policy statement. The RBNZ stated that the high NZD is adding further pressure to the dairy and manufacturing sectors and is holding down tradable goods inflation. A decline in the exchange rate is needed. The NZD was sold off from 0.7020 to 0.6960 at the time of writing.

 

RBNZ may need to lower OCR to 1.5%

Financial markets have priced in our view that the RBNZ will lower the Official Cash Rate (OCR) by 25bp to 2% on 11 August. In the next monetary policy forecast in September, it is likely that the RBNZ will lower their inflation and 3 month bill forecast. We judge that the risk has increased substantially that the RBNZ may follow up with another 25bp rate cut in early 2017 (almost fully priced in by financial markets) if the NZD remains uncomfortably stronger than expected. Given that the NZD TWI is still more than 5% stronger (after this morning’s decline) than the RBNZ’s forecast for the end of this year, a much lower 3 month bill forecast may be needed in the September monetary policy meeting. We do not rule out a terminal OCR rate of 1.5% in 2017.