New Zealand Dollar is the Best Performer on Whispers of November RBNZ Rate Hike

- RBNZ could raise rates as soon as Nov.
- This puts NZD on the front foot
- Two investment banks eye EUR/NZD downside

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The New Zealand Dollar is the best performing major currency of the past week, a performance linked to a decisive shift in investor expectations regarding interest rates at the Reserve Bank of New Zealand.

Jane Foley, Senior FX Strategist at Rabobank says the Reserve Bank of New Zealand (RBNZ) could well be the first major central bank to raise interest rates in a process referred to as policy normalisation.

Foley says recent outperformance in the NZ Dollar "is testament to the ratcheting up of RBNZ rate hike expectations."

"The RBNZ is now widely considered to be well ahead of the BoC in terms of rate hike potential," she adds.

Policy normalisation - the ending of the extraordinary policy response to the Covid crisis - involves lifting interest rates and ending quantitative easing (the purchase of assets such as bonds to keep interest rates right across the economy low).

The currency market is currently in a regime where those central banks that lead the pack on normalisation can be expected to see their currencies outperform, with those belonging to central banks that are lagging in the race underperforming.

New Zealand Dollar outperformance

Above: The NZ Dollar has risen against all its major peers during the past week.

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Foley notes that there is even talk of the RBNZ raising interest rates as early as November 2021.

The lifting of interest rates in New Zealand would be a necessary response to the outperformance of the economy relative to the RBNZ's previous forecasts.

GDP growth is cooking, with 1.6% q/q growth being reported in the first quarter.

Sentiment was bolstered further this week by the New Zealand Institute of Economic Research (NZIER) quarterly QSBO survey which showed a strong pick-up in both demand and confidence.

NZ GDP forecasts

Above: Lower starting point for growth, but forecasts revised up for the next two year by NZIESR.

The survey showed that a net 26% of businesses reported increased demand during the second quarter.

"The Q2 NZIER Business Survey points to a fairly strong turnaround in the coming six months with hiring intentions and investment shifting meaningfully higher. This has compelled speculation that the RBNZ might hike as soon as this year," says Mazen Issa, Senior FX Strategist at TD Securities.

The survey also noted inflationary pressures were building rapidly amidst a shortage of labour which was squeezing wages higher. In addition, global supply shortages that are pushing up inflation across the globe are also being reported in New Zealand.

Given that the RBNZ's primary objective is to ensure stability in inflation, expectations are growing that a rate rise will be required to cool these price pressures.

"We prefer to focus on currencies where there is no ambiguity in the policy stance. The BOC, RBNZ and Norges remain on the 'hawkish' frontlines," adds Issa.

The RBNZ will present its latest update on July 14 and given recent developments in the economy and shifting investor expectations it could provide some volatility for New Zealand Dollar exchange rates.

"Given that both yields and the NZD have already adjusted higher, monetary conditions have already tightened and we see scope for the RBNZ to temper some of the enthusiasm about rate hike potential in the coming weeks," says Foley.

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Such an outcome that cools existing rate hike expectations would likely send the New Zealand Dollar lower as recent gains are unwound.

But Foley says ultimately the RBNZ is still set to be more hawkish than most other G10 central banks, particularly the European Central Bank (ECB).

Indeed, the strategist eyes the Euro as particularly vulnerable to NZ Dollar outperformance as a result.

"Given that we expect the USD to remain on the front foot this summer given the focus on the possibility of Fed tapering, we would favour buying dips in the NZD vs. the EUR," says Foley.

Rabobank see scope for a move back to the February low at in the EUR/NZD 1.63 area on a 3 month view.

TD Securities also eye the EUR/NZD as a target to pursue.

"The RBNZ might hike as soon as this year. While we have penciled in fall of 2022, the macro and policy dichotomy between the antipodes suggests that AUDNZD rallies should be faded, and EURNZD still has runway to make a retest of 1.65," says Issa.

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