Stephen Toplis –
New Zealand’s inflation is low or at least at an average level, with the Consumers Price Index increasing 0.4% in the June quarter.
This lifted the annual rate of inflation, but to only 0.3%, from 0.1%.
We still see inflation bucking up toward 3% through next year, underpinned by the slumping currency. However, last week’s CPI details, choppier economic data and, notably, the 17% slump in dairy export prices since the June Monetary Policy Statement, will probably convince the Reserve Bank of New Zealand (RBNZ) to cut its policy rate all the way back to 2.50% by October.
While we don’t see all of this as a fait accompli, even a preferred course for the Official Cash Rate (OCR), we are conscious of the frame of mind of RBNZ, given the tack it took in its June Monetary Policy Statement.
We would rather play it this way, and become convinced that the Bank might hold its horses at some point, rather than arguing the toss, meeting to meeting.
There are no major local data releases over the next fortnight (not even another dairy auction). But, as we say, keep an eye on that slumping currency.
Outlook and Strategy
We now see the RBNZ cutting the OCR to 2.50% by October.
This would reverse the 100bps of hikes delivered last year. Our view is now a bit more aggressive than current market pricing that sees a low in the OCR of around 2.56% by the First Quarter next year.
The change to our OCR forecasts adds conviction to three key rates views.
First, the New Zealand short-end yields should trade lower near-term; we now look for two-year swap to trade down to 2.7%.
Second, we expect a steeper 2-10s swap curve and now see a 75-125bps range through to year-end. Third, we expect NZ 10y bonds to outperform US equivalents; we target NZ-US 10-year- bond compression to 70bps from current levels around 95bps.
Currency Outlook
We now forecast the trough in NZD/USD to be 0.60 in Q1 2016, materially deeper and slightly earlier than previously envisaged. This embodies a sharp descent from current levels.
There is little reason to countenance a rally driven by local factors in the near-term.
We anticipate that RBNZ will deliver the July and September rate cuts with a prominent easing bias. But it is the commencement of the tightening cycle of the Federal Reserve in the US that will do the lion’s share of the work in driving NZD/USD lower.
The current correction already ranks the sharpest (on a cyclical basis) that NZD/USD has seen since the 1985 float, with the exception of the Global Financial Crisis.
Stephen Toplis is Head of Research at BNZ, the Title Sponsor of the Indian Newslink Indian Business Awards 2015 and Sponsor of the ‘Best Large Business’ and ‘Supreme Business of the Year.’
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