The RBNZ is preparing for back-to-back interest rate hikes

The Reserve Bank of New Zealand (RBNZ) is widely expected to follow up last month’s hike in the official cash rate (OCR) with another rate hike this Thursday (0900 NZST). Swap markets are pricing in around a 97% chance that the RBNZ will raise the OCR by 25 bps to 3.00%, despite less than impressive inflation data for last quarter and falling dairy prices. Consumer prices rose a measly 0.3% q/q last quarter, missing an expected 0.5% rise (year-on-year inflation is around 1.5%). There is some concern in the market that Q1’s begin inflation figures and softer dairy prices will lead the RBNZ to adjust its policy outlook. Also, high levels of household debt complicate the bank’s strategy for higher rates. It’s unclear how households will respond to what is predicted to be a period of rapidly rising interest rates (the RBNZ is expecting the OCR to breach 5% in 2017).

Inflationary pressures remain

However, dairy prices are at historically high levels, thus some moderation in prices is to be expected. And, while inflation remains constrained in the near-term, consumer prices are expected to take off over the next two years (the RBNZ mentioned as much in last quarter’s Monetary Policy Statement (MPS)), and the bank has an obligation to maintain price stability (its target for inflation is around 2%).

Rising house prices and a strong economy are expected to continue to put upward pressure on inflation. Restrictions on loan-to-value ratio mortgage lending and high levels of household debt are helping to ease prices pressures in the housing market, but this is being partially offset by an increase in net immigration. Also, earthquake reconstruction efforts are bolstering economic growth and spurring prices in non-tradable sectors of the economy. In the tradeable sector, the RBNZ has been quick to point out that weak import price growth due to a strong exchange rate is subduing inflationary pressures from this part of the economy, but this is being more than offset by rising prices non-tradeable sectors.

The kiwi

Despite the negative impact that a high exchange rate is having on the economy, the RBNZ hasn’t been as vocal as it has in the past about how overvalued it thinks the NZ dollar is. In recent statements the bank has simply stated that it doesn’t believe that the current level of the exchange rate is sustainable over the long-term. So, will the bank use the recent fall in dairy prices to talk down the commodity currency this time around?

Market impact

Despite our belief that the RBNZ will continue on its current aggressive monetary policy course, the risk appears to be to the downside for the kiwi from tomorrow’s meeting. Those markets participations looking to carry or speculate may have already put their money on the table, thus the chance of a surprise move to the upside from this week’s meeting is diminished. Also, the recent disappointing data releases and falling dairy prices may make the bank more inclined to talk down the kiwi. In saying that, if Governor Wheeler fails to deviate at all from the bank’s current policy path or on its meek stance on the kiwi, it may spark a relief rally in the commodity currency immediately following the meeting. Also, the technicals appear to be in favour of a rally in NZDUSD at the moment.

Source: FOREX.com