New Zealand Dollar Shoots Higher as RBNZ Take a Step Back, Direct FX Market Intervention Grows

The New Zealand dollar is an outperformer on global currency markets on Thursday the 28th of April as the Reserve Bank of New Zealand fails to cut interest rates at their April policy meeting.

• Interest rate cut at the RBNZ likely in June
• Direct foreign exchange market intervention by RBNZ becoming increasingly likely

The pound to New Zealand dollar (GBP/NZD) is unwinding its recent gains and it is looking increasingly likely that the change in trend we saw taking place over recent days will be negated.

At the time of writing the GBP to NZD conversion is at 2.1007, well off yesterday's best at 2.1345. Bank transfers are being quoted as low as 2.0252 at present while tighter spreads at specialist payment providers see rates towards 2.0790.

The NZD to USD conversion trades at 1.4374, down from the previous day's close at 1.4629.

The Reserve Bank of New Zealand (RBNZ) held its official cash rate unchanged at 2.25% this morning in a move that bouyed confidence in the local currency.

Policy direction remains tilted to an easing bias however and Governor Wheeler noted, "further policy easing may be required to ensure that future average inflation settles near the middle of the target range." 

The central bank also reiterated that the kiwi remains higher than appropriate and that a lower NZD is favoured to boost inflation and trade.

This hint of unease was by no means strong enough to deter markets from buying the NZD in quantities. The strength of the NZD move higher also betrays how uncertain markets were heading into the event.

Only when there is an element of unexpectedness does a currency move to such a degree.

Recall the surprise cut last month? The move was a surprise and has reminded markets that this is a Bank that does not care much for meeting expectations when trying to promote economic growth and inflation.

Quite rightly, any impact is best achieved by surprising when it comes to central banks.

Markets were pricing a 40-50% chance of another interest rate cut below the current 2.25% even though economic data appears to be moving in the right direction and suggests previous rate cuts are working:

(1) Inflation has risen, 4Q15 GDP surprised to the upside
(2) New Zealand’s terms of trade are improving with dairy prices recovering 6% in April
(3) Greater stability in global financial markets

There is also the added concern that house prices continue to rise at break-neck speed, up 10% in March and the RBNZ risks adding fuel to an already red-hot housing market if it cuts interest rates again.

We have noted before that the RBNZ may be prompted into altering lending rules and expand existing restrictions beyond Aukland. Such a move over coming weeks would be a dead-cert sign that that the RBNZ is laying the groundwork for aggressive interest rate cuts.

Latest Pound / New Zealand Dollar Exchange Rates

	Live: 2.3128▲ 0% 12 Month Best: 2.3553
*Your Bank's Retail Rate	2.2342 - 2.2434
**Independent Specialist	2.2804 - 2.2897 Find out why this is a better rate

* Bank rates according to latest IMTI data.

** RationalFX dealing desk quotation.

 

NZD Strength Poses a dilemma for the RBNZ

With data heading in the right direction, and house prices heating up, why would the RBNZ want to cut rates?

One thing that has alluded the RBNZ so far, however, is a weaker New Zealand dollar.

The trade-weighted New Zealand dollar has rallied agressively since the turn of the year, as it does it pushes up the relative cost of New Zealand exports (such as the all-important dairy price) thereby acting as a drag on the economy.

Furthermore the NZD is likely to see this strength stick as global investors pour money into New Zealand to take advantage of high interest rates in a phenomenon known as the carry trade.

“We note that a more buoyant and stable risk environment has seen carry trades come back in fashion; in this regard, New Zealand’s high-quality and high-yield status is an attractive proposition for investors in a low conviction market,” says Viraj Patel, a Foreign Exchange Strategist with ING in London.

Patel suspects that the RBNZ will be concerned over the nature of the kiwi rally and further easing will be necessary to deter speculative NZD inflows.

"We still see sufficient arguments for additional easing in 2016,” says Patel, “while we are swaying towards thinking that the RBNZ will hold fire for now (ie, saving their ammunition for more testing times), we continue to look for a June rate cut in the absence of any improvement in the inflation outlook."

Recall that the RBNZ have signalled two further rate cuts over a 12M horizon via their forward interest rate projections in the MPS.

Will the RBNZ Threaten FX Intervention to Stem NZD Upside?

ING reckon that anything but the deepest cuts to the 2.25% OCR are likely to be ineffective in foiling NZD strength in the current risk-on market.

Therefore thoughts of FX intervention may well be on the minds of policymakers.

On 30 March 2004, the Government approved a Reserve Bank proposal that gives the Bank the capacity to use foreign exchange intervention in order to influence the level of the exchange rate.

This approach allows for intervention at the extremes of the exchange rate cycle, directed at leaning against trends in the exchange rate which the Bank assesses to be unjustified by economic fundamentals.

From what we have heard today, the bank may be feeling there is a detachment between the exchange rate and fundamentals.

"Historically, the bank has discreetly intervened in currency markets and then disclosed this information via their monthly FX reserve holdings data," notes Patel, "Hence, the likelihood of any explicit reference to FX intervention in the statement is low."

(Watch out for the next release of reserves data due 28 Apr).

Moreover, there may be a sense that "leaning-against-the wind" interventions could also prove futile in the current market setting.

Thus, ING feel that aggressive jawboning will remain the go-to option to deal with a strong NZD.

What Does this Mean for the Exchange Rate?

Risk-reward considerations see ING strategists prefering to fade NZD upside on the back of a rate cut disappointment this week.

“A constructive risk environment is providing artificial support for the NZD, with a dovish RBNZ playing second fiddle,” says Patel.

This is best depicted in AUD/NZD; 1Y swap rate spreads have moved 10bp in favour of a higher AUD/NZD after last month’s surprise RBNZ cut, yet the pair has traded sideways over the period.

Staying long AUD/NZD is still a preferred short-term tactical play for Patel, but he is wary that the RBA could turn dovish in 2H16, thereby undermining the recent strength seen in the AUD.

Given a currency-sensitive RBNZ and signs of overstated USD weakness, “we prefer to stay short NZD/USD – noting that the pair remains particularly vulnerable to a rebound in US data,” says Patel.

NZD Unlikely to Push GBP Through 0.50 Barrier

Turning to the GBP/NZD exchange rate, sterling remains well bid right across the board. 

After blasting through 1.44 against the US dollar at the end of last week and 1.45 yesterday, overnight it broke through 1.46 before retracing a little to 1.4580.

Traders have been net short GBP as Brexit fears rose, but current polling and sentiment suggests that those fears might have been overdone and the currency is now on a reverse course.

"Over the last week, NZD/GBP has swiftly fallen from close to 0.49 to 0.4720 this morning.  We feared a push up through 0.50 if Brexit risks intensified, but that is now looking less likely by the day," says analyst Jason Wong at BNZ in Aukland.

Looking at these levels from a GBP/NZD position, 0.49 = 2.0408, 0.50 = 2.0.