New Zealand Dollar Strength Unsustainable Warn ABN Amro

Markets are prematurely discounting the prospect of future interest rate cuts in New Zealand say ABN Amro.

In a move which may have suprised market participants, the New Zealand dollar rose following the RBNZ's decision to cut its official cash rate to 2.5% on Wednesday.

"The RBNZ cut rates by 25bp to 2.5% and the NZD rallied sharply. There’s a pattern here! March Bill futures fell back a little as the market is reluctant to embrace the idea of further rate cuts in this cycle and NZD shorts are being cut back as year-end approaches," says Kit Juckes at Societe Generale.

The currency may have risen due to a comparatively less dovish statament, as unlike previous meetings, which anticipated future easing, there was no explicit sign of another rate cut in the pipeline, except in certain circumstances, and as a result the exchange rate, which after initially spiking lower, started to strengthen, rising to 2.2518 versus the pound.

"It was the delivery of the cut which sent the NZD higher, with the RBNZ suggesting this cut will be the last with inflation now expected to shift higher. GBP/NZD is at risk of a move down to new multi-month lows," suggests Nawaz Ali at Western Union.

Nevertheless the bank's reiterated its policy stance remained broadely loose: “Monetary Policy needs to remain accommodative to help ensure that future inflation settles near to the middle of the target range.”

At the time of writing the pound to New Zealand dollar exchange rate is trading at 2.2551 on the inter-bank markets. Your bank will most likely be offering a transfer rate around 2.19 though as they tend to subtract large spreads.

Independents are seen offering tighter spreads and a rate of 2.22 was last quoted at RationalFX.

Forecasts pushed back a quarter

RBNZ pushed back forecasts of hitting its target by a quarter, which was seen as quite a modest delay, and therefore not as doveish as market had expected.

Governor Wheeler said that there was a very wide divergence between headline inflation, which was running at 0.4% and core inflation which was at 1.5% and much nearer the target range.

Global factors were a concern, including the slowdown in major trading partner China, the continued fall in commodities, the slow-down in global growth and the threat of the El Niño hurricane, which will probably cross sections of New-Zealand.

Housing Market Bubble

The continued appreciation in the Aukland housing market posed a “financial stability risk,” according to RBNZ, and was seen as a counterbalancing force against aggressive monetary easing.

High migration was a major factor in the Aukland housing bubble and the central bank highlighted how changes in rates of migration might affect house prices in the future.

Outflows of Kiwi’s had fallen, whilst the inflow, though difficult to access, had risen to compromise 3.0% of the workforce.

Migration was also partly responsible for increasing slack in the economy, and further weighing on inflation.

There was no expectation of the government changing its policy in relation to migration.

View of the Fed

In response to a question about the Federal Reserve’s expected rate cut, Governor Wheeler said that the dollar had remained fairly range-bound against major partners over the last few months, implying that a rate rise might already be priced in.

He added that: "the dollar is 14% above the average exchange rate since 1971," indicating it might already be overvalued.

Another member of the board commented that the monetary policy climate had changed and that central banks have to remain accommodative for longer now-days.

He added: “The lags in monetary policy seemed to have extended.”

More Cuts Could Happen

Don't bet on an extension in the NZ dollar rally warn ABM Amro.

The Dutch bank acknowledges that the manufacturing and service sectors in New Zealand have showed resilience but there remains the risk of further RBNZ easing within the next six months.

In addition to the uncertainty surrounding the potential impact of El Nino on farmers and the persistence of low diary prices, the New Zealand unemployment rate is expected to tick higher by 20bp to 6.2% in 2016.

Therefore, while the NZD outlook may be short term positive, the long term remains negative, says ANB AMRO.