New Zealand Dollar Suffers Brutal Losses after RBNZ Warns of Likely Rate Cut

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- NZD crushed after RBNZ returns to warning of rate cuts.

- RBNZ has now shifted to an easing stance, cuts to come.

- Cites global slowdown that's impacting the inflation outlook.

The New Zealand Dollar fell sharply against the Pound and other rivals Wednesday after the Reserve Bank of New Zealand (RBNZ) warned that it might have to cut its interest rate over the coming months.

RBNZ Governor Adrian Orr cited a decline in domestic spending and a further slowdown in global growth as risks to the outlook for inflation, which has long been below the midpoint of the 1%-to-3% target, as being behind what looks like a shift into an "easing" stance.

"Given the weaker global economic outlook and reduced momentum in domestic spending, the more likely direction of our next OCR move is down. Employment is near its maximum sustainable level. However, core consumer price inflation remains below our 2 percent target mid-point, necessitating continued supportive monetary policy," Orr says, in his March policy statement.  

The RBNZ had previously said the next move in the cash rate might be either up or down, with an equal probability assigned to either scenario. But the latest statement was much less ambiguous.

Orr singled out Australia, the Eurozone and China as being among the main economies to have shown signs of slowing further this year. Growth across all three fell sharply during the second half of the year, but particularly in Australia and the Eurozone. 

Interest rate cuts are usually negative for currencies because they reduce the attractiveness of related investments, particularly those in the bond market. They do that by reducing, or widening already-negative, interest rate differentials.

International capital tends to flow wherever relative interest returns are most favourable. New Zealand's interest rate has been at a record low of 1.75% ever since the end of 2016, but since that time, interest rates in some other parts of the developed world have risen. 

“We continue to forecast that the next OCR move is down, but the risk is now that it comes earlier than our forecast of November, given the RBNZ’s tone has shifted to be overtly dovish a little earlier than we thought it might. Like the RBNZ, we’ll be watching both the domestic and global dataflow closely.” says Sharon Zollner, chief economist at ANZ.  

The U.S. Fed Funds rate of 2.5% is now higher than in New Zealand, the UK Bank Rate is 0.5% higher than it was at the end of 2016 and Canada's interest rate has risen from 0.5% to 1.75% during the intervening period. 

However, the above developed world central banks have recently begun to suggest the days of rising rates are over, leading markets to speculate that U.S. and Canadian rates at the very least, may soon be cut.

That drove a recovery of the New Zealand Dollar heading during 2019 and into Wednesday's meeting, one which was further undermining the inflation outlook by making imported goods cheaper for Kiwis to buy.

Interest rate decisions are normally only taken in response to changes in the inflation outlook, with rate cuts being used to stoke economic demand and lift inflation toward its target, while rate hikes are deployed to cool demand in the economy and bring inflation down once it has overshot the target level.

"The RBNZ surprised on the dovish side overnight. Although it kept interest rates unchanged, it signalled that the next move Is likely to be a cut, joining the dovish cohort of central banks globally," says Petr Krpata, a strategist at ING Group. "With the NZD underperforming G10 peers, we also see negative spillover effect into AUD where the market pricing of more than one 25bp cut by year-end has been indirectly validated by the RBNZ message today." 

The Pound-to-New-Zealand-Dollar rate was 1.63% higher at 1.9434 during noon trading in London Wednesday, while the NZD/USD rate was quoted -1.67% lower at 0.6792 Wednesday but is still up by 1.2% for 2019.  

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