Reserve Bank of New Zealand Preview: Kiwi needs a double shot hike to fly higher amid geopolitical risks

NZD/USD is sitting pretty at weekly highs above 0.6700 amid hopes for diplomacy in the Ukraine crisis. Kiwi traders are gearing up for yet another rate liftoff from the Reserve Bank of New Zealand (RBNZ) this Wednesday, its first interest rate decision of the year. Aggressive RBNZ tightening remains well on the table this year after large upside surprises to New Zealand’s inflation and labor market while the immediate focus now is on this week’s announcement.

OCR hike: Single or double shot?

The RBNZ is widely expected to deliver 25 basis points (bps) to the Official Cash Rate (OCR) on February 23, raising it to 1.0% from 0.75% previous.
Wednesday’s likely rate hike will be the central bank’s third in a row, with the overnight index swaps (OIS) roughly pricing in seven rate hikes from the kiwi central bank this year.

The rate decision will be announced on Wednesday at 0100 GMT, followed by Governor Adrian Orr’s press conference at 0200 GMT. Fresh economic projections will grab some attention, as a 25 bps rate hike is fully baked in.

Hotter inflation and tightening labor market conditions will compel the RBNZ to act, although the question remains by how much. A 25 bps liftoff is fully priced-in while some market participants expect the central bank to surprise with a 50 bps rate increase, in an attempt to fill in the January gap.  

New Zealand's inflation soared to the highest level in three decades, arriving at 5.9% YoY in the fourth quarter, way past the central bank’s 1-3% target range. Meanwhile, the country’s unemployment rate recorded a fresh all-time low of 3.2% in the same period.

The improving economic picture does justify a likely tightening by the RBNZ, although a 50 bps rate hike could put the economic recovery under stress, as the economy passes through the impact of the Omicron covid outbreak.

Further, the central bank may acknowledge the rife geopolitical tensions between the US and Russia over the Ukraine crisis, which could keep it away from going on too aggressively with its tightening plans this month.

Such is the case with the US Federal Reserve (Fed) as well, as markets are now dialing back a 50 bps March rate increase.

To add, RBNZ Deputy Governor Christian Hawkesby said in October the central bank would be hiking rates by 25 bps, not 50 bps, at meetings due to the heightened uncertainty.

Trading NZD/USD with RBNZ decision

Market’s perception of the risk sentiment, in the face of looming geopolitical risks, concerning Russia and Ukraine will continue to remain the main market motor. Investors should refrain, therefore, from placing any big bets on the kiwi ahead of Wednesday’s RBNZ announcements.

On the interest rate decision, NZD/USD could see some initial reaction, depending on the dovish or hawkish outcome.

The currency pair could see a ‘sell the fact’ trade unfold if the RBNZ delivers the expected 25 bps hike. The kiwi could correct sharply towards 0.6600.

On a 50 bps surprise rate increase, the pair could receive a much-needed shot in the arm, which may trigger a fresh upswing towards January highs above 0.6800.

Governor Orr’s comments on inflation and the economy will also have a significant impact on the kiwi dollar.