NZD/USD: Ahead of RBNZ Policy Meeting

Overnight, the US dollar strengthened modestly, causing the dollar index to rise above the 104.00-level. Notably, the New Zealand dollar has fallen by about 0.5%, making the US dollar gains more apparent. Currently, the NZD/USD rate is approaching support from the 200-day moving average at 0.6187 (D1) after having tested this support multiple times since December, and it has held up so far.

The hawkish repricing of Fed rate hike expectations is further supporting the US dollar in the short term. To determine the Fed's policy outlook in the upcoming week, the release of the latest FOMC minutes from the 1st February meeting and a discussion on inflation by New York Fed President Williams are two crucial events to monitor. Following the unexpectedly firm US CPI and PPI reports earlier this year, there is a heightened risk that the Fed may increase rates above 5.00%, leading to renewed upward pressure on short-term US yields and the US dollar.

Conversely, the weakness of the New Zealand dollar may indicate concern over the possibility that the RBNZ could convey a less hawkish message at the upcoming policy meeting. However, this risk appears less probable now due to recent developments. Specifically, the New Zealand government announced an interim emergency relief package to aid regions affected by Cyclone Gabrielle and the January floods. The package includes NZD250 million to help the New Zealand agency Waka Kotahi and local councils evaluate and repair roads, as well as NZD50 million for emergency business and primary sector support.

In a fortnightly economic update issued yesterday, the Treasury department remarked that the additional demand for recovery and rebuilding in an already capacity-constrained economy would contribute to inflationary pressures. Consequently, Cyclone Gabrielle might prompt the RBNZ to maintain interest rates at a higher level for a more extended period than it had planned, supporting expectations for the RBNZ to implement another substantial 50bps hike at tomorrow's policy meeting.

Nevertheless, signs of diminishing labour market pressures, decreasing inflation expectations, and the probability of a lower inflation peak (projected at 7.2% in Q4 vs. RBNZ's estimate of 7.5%) still sustain the view that the RBNZ could signal that rates do not need to rise as high as previously planned up to 5.50%. These expectations for a lower terminal policy rate are one of the factors weighing on the kiwi before the policy meeting today in a few hours (22/02/2023 at 12pm Sydney Time).

Following the recent flood and cyclone, my forecast is more modest 25bp hike by the RBNZ (rather than 50bp) for today. I want to bring the attention to a few aspects: i) it would be sympathetic to the disaster and had “form” in responding promptly to such large negative shocks; and ii) it has already tightened aggressively such that monetary policy is already tight. I also note that Q4 CPI inflation data were weaker than its forecasts and the latest two-year inflation expectations data showed a welcomed easing (from 3.62% to 3.30%).

However, the latest news flows from New Zealand has rattled my confidence in this view somewhat. And I’ve noted that:

• The NZ Treasury has indicated today that the coming rebuild will support activity, and increasing demand will add to inflation, such that the cash rate could remain higher for longer;
• The NZ Finance Minister has announced initial funding to support reconstruction and has said that the RBNZ’s job is to control inflation; and
• Local banks are offering some limited short-term loans at zero or near-zero interest rates to impacted people, and temporary holidays on home loan repayments

It is possible that the New Zealand government's support measures, as well as those provided by local banks, will allow the RBNZ to focus on its inflation mandate.

However, given the already tight monetary policy and considering the potential impact on people's lives, the RBNZ may be hesitant to hike rates further and may instead opt for a more modest 25 basis points hike, or even pause altogether. While a concessional 25 basis points hike is still the central case, recent developments have reduced the conviction around this forecast.

There are several potential outcomes for the meeting, including a "dovish 50 basis points hike," where the RBNZ hikes by 50 basis points but signals that it intends to pause for some time, and;

"Hawkish 25 basis points hike" or "hawkish pause," where the RBNZ may pause or deliver a modest hike but indicate that further hiking will likely be required in the future. The RBNZ is also set to deliver updated quarterly forecasts, but given the extreme near-term uncertainty, caution is advised when interpreting these forecasts.

The new forecasts may show a deeper recession in the near term due to weather-induced events, and while there had been thoughts of a lower terminal cash rate, this is now less clear.

This content may have been written by a third party. ACY makes no representation or warranty and assumes no liability as to the accuracy or completeness of the information provided, nor any loss arising from any investment based on a recommendation, forecast or other information supplied by any third-party. This content is information only, and does not constitute financial, investment or other advice on which you can rely.