Steen Jakobsen
The Bank of Japan has abandoned quantitative easing and the European Central Bank may taper its bond-buying programme, so what is the role of central banks in 2017, asks Saxo Bank’s chief economist Steen Jakobsen.
Article / 21 July 2016 at 1:55 GMT

RBNZ prompts Kiwi sell-off but markets want action, not talk

Managing Director / Technical Research Limited
New Zealand
  • RBNZ says exchange rate decline needed to counter weak inflation
  • Markets raise to 80% probability 2.25% rate will be cut by 25 basis points
  • NZDUSD fell off last week's multi-month high of 0.7325 to trade at 0.6960
  • If the RBA cuts to 1.5% on Aug 2, RBNZ will almost certainly follow suit to 2.00%
  • But the New Zealand economy does not need a rate cut
  • The (risky) option of FX market intervention remains a possibility

By Max McKegg

NZDUSD slipped under 0.7000 for the first time in 12 months after the Reserve Bank of New Zealand issued a brief economic update earlier today. The catalyst was the sentence “a decline in the exchange rate is needed” to counter a weaker inflation outlook. It seems the bank hopes to engineer this decline via “further policy easing”, and markets have responded by raising to 80% the probability the 2.25% policy rate will be cut by 25 basis points in the Aug 11 Monetary Policy Statement.

 'House price inflation remains excessive,' says RBNZ. It's hardly time for lower mortgage rates. Photo: iStock
FX traders were on the alert for a move in the currency after the RBNZ issued a statement last week saying they would issue a preliminary statement this week ahead of an official statement in three weeks! Naturally this confused traders and the when-in-doubt-sell-out mantra took over, toppling NZDUSD off its multi-month high of 0.7325 recorded a week ago. It’s now trading at 0.6960.
Central bank communications are carefully worded these days and traders noted the subtle change from “further policy easing may be required” in the June Monetary Policy Statement to “at this stage it seems likely that further policy will be required” in today’s update. So a change from “may” to “will”. The statement finished with the comment “we will continue to watch closely the emerging economic data” but, in reality, the main event will be the Reserve Bank of Australia’s own monetary policy review on Aug 2. If the RBA cuts to 1.5% the RBNZ will almost certainly follow suit to 2.00%.
NZDAUD has risen close to parity in recent weeks and, because it has a high weighting in New Zealand’s Trade Weighted Index (TWI), the RBNZ can’t afford to let the interest rate differential with Australia widen. New Zealand’s exchange rate, as measured by the TWI, is shown in the chart below. Today’s statement noted the “trade weighted exchange rate is 6% higher than assumed in the June statement”. That assumption is shown by the Reserve Bank projections line in the chart. After today’s moves in the crosses that make up the TWI, the gap has been cut almost in half.

NZ TWI chart (click to enlarge)
The bank needs the gap to close right up if it is to have any chance of getting inflation back up into its 1%-3% target range. So how to do it ?
One option would be to cross fingers and hope the US Federal Reserve will come to the rescue by raising rates in September (now a 30% chance, according to Fed Funds futures). NZDUSD would, presumably, sell off in that scenario. But not necessarily: as this chart shows, the interest rate gap in New Zealand’s favour has been narrowing for some time, yet NZDUSD has been moving up.

NZDUSD chart
A second option is to go it alone and cut domestic rates (and perhaps hoping the Reserve Bank of Australia sits on its hands on Aug 2). However, unilateral action is no guarantee either. As the dotted lines in the top chart show, previous rate cuts have had mixed success in bringing down the TWI.
Option three would be intervention in the FX market, an issue I addressed here.
Come south young man
The intervention option is attractive because the economy does not need a rate cut. The RBNZ says, “Domestic growth is expected to remain supported by strong inward migration, construction activity, tourism and accommodative monetary policy.” Furthermore, “House price inflation remains excessive.” It's hardly a time for lower mortgage rates.
The latest numbers on permanent long-term arrivals (PLT) were also released today and, while the net inflow is still high, there are signs the peak may have been reached. This will be a modicum of good news for the RBNZ.

NZ permanent long-term arrivals
The house price inflation problem has been a hot potato passed between the government and Reserve Bank Governor Graeme Wheeler. The politicians want him to cool the market, but not collapse it (that would be bad for their re-election chances). Wheeler wants to government to take the initiative so he can match monetary policy settings to the inflation outlook, rather than hold interest rates up for fear of adding fuel to the real estate fire. He recently tightened up on loan requirements for investors so at least somebody was seen to be “doing something”.
Today’s interim economic statement from the Reserve Bank of New Zealand had the desired effect of knocking NZDUSD back under 0.7000 for the first time in 12 months. But more downward movement is needed if the bank is to reach its inflation target. Their next move will probably be a cut to the 2.25% policy rate on Aug 11 and this will be a done deal if the Reserve Bank of Australia leads the way on Aug 2. The (risky) option of FX market intervention remains a possibility.

– Edited by Susan McDonald

Max McKegg is managing director of Technical Research Limited. If you would like an email notice each time Max posts a trade or article then click here or post your comment below to engage with Saxo Bank's social trading platform.
21 July
Patto Patto
Do you think NZDUSD will go lower from here Max?
21 July
Max McKegg Max McKegg
probably fallen enough in the short term


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