Are More Rate Cuts on the Way for the NZD?

Key Points:

RBNZ cuts the OCR by 25bps.

Medium term OCR rate around 1.50% probable.

Expect 25bps cut at September RBNZ meeting.

The New Zealand Dollar has largely been on a rollercoaster over the past 12 hours as the market continually repositioned ahead of the Reserve Bank’s decision on interest rates. In a move that was of little surprise to currency markets, the central bank decided to cut the official cash rate 25bps to 2.00%.  However, the risk of a 50bps cut had largely been priced in, so instead of declining the NZDUSD actually rallied back about the 72 cent handle. Subsequently, many traders are left wondering if there are more cuts looming on the horizon.

The reality is that the Reserve Bank is currently dealing with a range of competing pressures, including a slowing domestic economy and a sharply over valued Kiwi Dollar. In particular, the exchange rate problem has been of great concern to the central bank given the role that relative rates play in global trade. Subsequently, the dairy industry and the comparative advantage that our tradable goods rely upon are likely to be damaged in the medium term by an overvalued NZD.

Subsequently, today’s cut to the official cash rate was largely designed to engineer a depreciation of the Kiwi Dollar rather than directly combat a slowdown in investment and spending. However, at this juncture it would appear that the move has largely failed in the short term with the NZDUSD rallying as the market’s expectations of a 50bps cut have been exposed.

So it should be of little surprise that the central bank is likely to wheel out further cuts to the OCR during the September meeting. Given the high exchange rate, as well as inflation’s location below the targeted band, it is highly likely that will we see a further 50bps cut between now and the end of the year. This would put the OCR at 1.50% which would allow the central bank to get ahead of any declining inflation as well as help to alleviate the currently over valued Kiwi Dollar.

Ultimately, any further moves by the RBNZ will largely predispose the NZDUSD to the downside and we could very well see a valuation around the 0.67 – 0.68 mark in the final quarter of 2016. The 70 cent handle is likely to remain the key battleground in the coming months with a concerted breach likely to lead to a sharp depreciation.