New Zealand Dollar Falls after RBNZ Leaves Threat of an Interest Rate Cut Hanging in the Air

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- NZD falls after RBNZ underlines negative interest rate outlook.

- Economic growth must pick up for an interest rate cut to be avoided.

- Analysts say outlook to ensure NZD remains an underperformer.

The New Zealand Dollar shifted into reverse and slipped lower Thursday after the Reserve Bank of New Zealand (RBNZ) made clear it needs to see a pickup in economic growth over coming months if an interest rate cut is to be avoided.

RBNZ governor Adrian Orr told markets that New Zealand's interest rate is likely to remain at its current record low of 1.75% through 2019 and into 2020. It goes almost without saying that he left rates unchanged at 1.755 on Wednesday.

"We expect to keep the OCR at this level through 2019 and into 2020. The direction of our next OCR move could be up or down," says Adrian Orr, in a statement. "Employment is around its sustainable level and consumer price inflation remains below the 2 percent mid-point of our target, necessitating continued supportive monetary policy. Our outlook for the OCR assumes the pace of growth will pick up over the coming year."

This underlines the deterioration in the New Zealand interest rate outlook since July, when markets had been betting the RBNZ would increase its cash rate around the middle of 2019.

However, Orr made clear that even this diminished outlook for Kiwi rates is contingent upon a pickup in economic growth over coming years. One that appears unlikely given that even members of the government themselves have said in recent quarters that they see an economic slowdown on the horizon.

In other words, if economic growth does not rise during the coming quarters, the Reserve Bank of New Zealand may feel compelled to cut its interest rate again before it considers raising it. 

"With inflation still low and the activity outlook uncertain, the RBNZ stands ready to act should the activity outlook disappoint. Accordingly, all eyes will be on the economic data-flow into the end of the year. While strength in GDP growth in the June quarter is positive, we continue to view a cut in the OCR as more likely than a hike, on balance," says Sharon Zollner, chief economist at Australia & New Zealand Banking Group (ANZ).

New Zealand's economy grew by 1% during the three months to the end of June which, up from 0.5% at the beginning of the year, was more than twice the 0.5% expansion the RBNZ had forecast. 

However, the jury is still out on the likely pace of growth ahead. Foreign Minister and leader of New Zealand First Winston Peters said when announcing the decision to go into coalition with the Labour Party, that the economy is headed for a rough patch.

Most analysts are forecasting steady growth at current sub-par levels for a while to come while the RBNZ said Wedensday that risks to its own outlook for the economy are tilted to the downside.

Governor Orr has said repeatedly recent months the next move in interest rates could either up or down and that the eventual change would be subject to developments around inflation. 

But now, with deputy governor John McDermott saying in August the odds of a rate cut have increased of late, financial markets are increasingly attuned to the possibility of a rate cut. 

The interventions dealt a blow to the Kiwi, helping it fall by 8% against the U.S. Dollar during the nine months to the beginning of September 2018 and 5% against Sterling. 

The NZD/USD rate was quoted 0.33% lower at 0.6640 Thursday, down by around 20 points since Wednesday's noon, while the Pound-to-New-Zealand-Dollar rate was down 0.04% at 1.1.9759. 

"We expect the NZD to be a notable underperformer over the coming quarters, as low inflation and sub-potential GDP growth support the prospect of RBNZ rate cuts over the coming year. The RBNZ continues to recognise this through its reference to the next move being up or down, and an alternative scenario added to the August MPS showing 100bp of rate cuts if GDP growth remained below trend," says Hamish Pepper, a currency strategist at Barclays.

The RBNZ has held its interest rate at its current record low ever since the end of 2016, citing weak wage growth and an outlook for the economy that are both placing attainment of its inflation target in jeopardy. Kiwi inflation has been below the midpoint of the 1% to 3% target ever since 2012.

Changes in interest rates, or hints of them being in the cards, are only made in response to movements in inflation but impact currencies because of the push and pull influence they have on international capital flows and their allure for short-term speculators.

"The kiwi has been fairly unmoved on the meeting – though the emphasis on trade tensions and downside risks to domestic growth has kept the mildly negative skew in the NZD OIS curve in place (with markets marginally seeing a cut as more likely than a hike in the next 3-6 months). This will likely mean that the short-term bearish NZD bias remains in place for now," says Viraj Patel, an FX strategist at ING Group.

Wednesday's decision comes hard on the heels of the latest ANZ business confidence survey, which showed optimism among the nation's companies recovering from a post-crisis nadir during September. 

Confidence rose to -38 in September, up by 12 points from a post-crisis low of -50, suggesting a lesser but still-substantial portion of New Zealand firms expect the general business environment to deteriorate over the next year. Firms' expectations of their own activity rose by four points, with a net 8% now anticipating their own situation will improve.

The confidence index has been below zero ever since September 2017, the month of New Zealand's last election, which marked the beginning of a process that culminated with the Labour Party entering office alongside coalition partner New Zealand First.

Coalition has given Labour the parliamentary majority needed to implement its cocktail of left-leaning and "populist" policies.

These include a 20% increase to the minimum wage by 2020, the cancellation of corporate tax cuts and roll-out of various new welfare programmes. Slashing migration and shutting foreign buyers out of the market for existing residential properties have also been among its early priorities.

The result for the economy has been a steep decline in confidence particularly among retailers and restaurants, who were hit hardest by the minimum wage increase, while expectations of an economic slowdown are mounting.

"Recent falls in employment and investment intentions from the ANZBO have been particularly noteworthy. While ASB remain poisitive in the domestic outlook, they caution that if weak sentiment persists, it may weigh on economic growth over the second half of 2018," says Kristina Clifton, an economist at Commonwealth Bank of Australia. 


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