News out from the venerable New Zealand central bank today highlighted a lacklustre inflationary environment that could see monetary easing on the horizon. Subsequently, the NZD turned largely bearish and declined sharply to trade around 0.6370.

The economic figure that sparked the selloff was primarily the NZ CPI result, which saw the inflation indicator fall to -0.5% in the December quarter, ending the year at a paltry 0.1%. Inflation has been one of the bright spots for the antipodean country over the past year with central bank estimates placing the figure within the 1.00% – 1.50% mark. However, the latest results demonstrate a sharply slowing economy that is very likely to impact monetary policy and the currency valuation in the coming months.

The absence of inflation has largely been explained away as being driven by the continually falling prices of crude oil along with the recent rout in the dairy market. However, there is no doubt that economic activity is slowing in the island nation, given the drawdown in building activity in Christchurch, as well as the delay of some other large infrastructure projects. Subsequently, the Reserve Bank of New Zealand now has a difficult job on their hands to manage the need to stimulate the economy whilst keeping house price inflation in check.

The RBNZ has been at the forefront of commentary of late suggesting that the Auckland property market represents a clear and present danger to the New Zealand economy. Given the rampant inflation in that sector of the economy, the central bank has been correct to be concerned about the overall solvency of investors and financial institutions. Subsequently, the implemented LVR lending limits have placed a new emphasis on debt serviceability which has helped to somewhat cool some of the demand. However, a cycle of interest rate easing could potentially ameliorate those changes and stoke instability in the property market.

Subsequently, the RBNZ is likely to remain relatively restrained with any cuts to the OCR until they feel that the property market has responded appropriately to the changes implemented in late 2015. However, the canny Governor Wheeler has made it clear that the central bank will ultimately not be hogtied by the inherent risk in the Auckland property market. I think it’s safe to say that Governor Wheeler will take a long term macro view rather than an Auckland centric model.

Moving forward, expect the RBNZ to seriously consider cutting the official cash rate 25bps to 2.25% during their next MPC meeting. Our forecast also suggests that at least one other cut will follow in the latter part of the year given the business cycle. Subsequently an forecasted OCR around the 2.00% by the third quarter is highly probable.

Ultimately, the Kiwi Dollar is in for a torrid few months as the market absorbs the data from a slowing economy and the lower interest rates. Currently the NZDUSD trades around the 0.6370 level but there is a lack of any real support until at least 0.6234. The reality is that any easing rhetoric is likely to see the NZD challenging the key 0.60 handle in short order. So prepare your short positions and hold on for a ride because the next few months are likely to see some carnage for the NZD.

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