New Zealand Dollar Slips after ANZ Survey Entrenches Downbeat Inflation Outlook

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- NZD dips as ANZ survey, RBNZ report, entrench negative outlook.

- ANZ survey shows inflation pressures ebbing, vindicates RBNZ cut.

- As RBNZ ploughs ahead with bank capital raising plans, eyes insurers.

- Westpac says NZD to see another leg lower, GBP/NZD outlook is binary.

The New Zealand Dollar was weaker on Wednesday after the May Australia & New Zealand Banking Group (ANZ) business confidence survey and latest Reserve Bank of New Zealand (RBNZ) financial stability report served markets with a reminder of the challenges ahead for the Kiwi currency.

ANZ's business confidence index rose from -37.5, which was close to a post-financial-crisis-low, to -32 in May but details within the report vindicated the Reserve Bank of New Zealand for its recent rate cut and may have entrenched a negative outlook for the currency.

Inflation pressures ebbed even further in New Zealand during May, the ANZ survey shows, which means the RBNZ still has its work cut out for it if the central bank is to see the consumer price index lift above the midpoint of the 1%-to-3% inflation target any time soon.

Many Kiwi companies told ANZ in May that they themselves expect to raise their prices this year but 'inflation expectations' fell to their lowest level since early 2017, with firms now anticipating price growth of just 1.81% this year, down from 2.04% previously.

Above: ANZ inflation expectations alongside RBNZ CPI forecasts.

This leaves inflation expectations headed in the wrong direction for the RBNZ at a time when many companies are anticipating a further cooling of the economy over the coming months, which is negative for the Kiwi currency because the central bank needs faster economic growth in order to meet its inflation target.

"Expectations entrenched away from the target would present a challenge for monetary policy. The recent fall to just under target may be related to the OCR cut in May and the associated commentary that more stimulus was required to deliver inflation at the 2% target midpoint over the medium term," says Sharon Zollner, chief economist at ANZ.

The Reserve Bank of New Zealand cut its interest rate to a new record low of 1.5% in May, citing years of below-target inflation and a deteriorating economic outlook that has so-far served to put attainment of the target further from view.

Financial markets are betting the bank will cut rates again before the year is out, most likely in November, while Wednesday's ANZ survey and RBNZ financial stability report vindicated investors for such speculation.

"The economy has cooled considerably over the past couple of years. The ANZ Light Traffic Index suggests weakness will continue to mid-year. Beyond that, the lower exchange rate and interest rates should see momentum recover, assuming the global outlook and the terms of trade do not deteriorate. But how quickly the economy will bounce back is a key question," Zollner adds.

Above: ANZ Business Confidence survey results.

The RBNZ hinted in May that further reductions to the cash rate would be necessary in order to get inflation back to target, but there's significant uncertainty about just how many more rate cuts will be needed.

The RBNZ's plan to have domestic banks almost double their capital buffers over the coming years could force it to cut rates further still because they will reduce profits in the sector, which could force lenders to raise their variable mortgage rates.

Such a move by the banking sector would risk sapping demand from the economy, and further weakening already-low inflation pressures, if it is not met with a matching interest rate cut by the RBNZ.

RBNZ Governor Adrian Orr said in the latest financial stability report Tuesday that an "ongoing effort" will be required to ensure the financial system is resilient enough to withstand future crises.

He also said the ongoing review of bank capital requirements, which is expected to culminate in decision before the end of November, is likely to be extended to include insurance firms and non-bank deposit takers.

Above: NZD/USD rate shown at daily intervals.

"Near term NZD/USD momentum has stalled, following a 4c decline since March. There’s potential for a corrective bounce to 0.6650, fueled by better business and consumer sentiment readings in the wake of the government’s cancellation of its proposed capital gains tax. However, we remain bearish multi-month, target one last push down to 0.6425, as NZ data overall should remain subdued in Q2 and Q3," says Imre Speizer, a strategist at Westpac.

Pricing in the overnight-index-swap market implies an RBNZ cash rate of 1.21% for November 13, which is far below the current 1.5% rate on the date of the bank's decision for that month, suggesting financial markets have already taken a second interest rate cut to bank.

As a result the New Zealand Dollar wouldn't necessarily suffer from a second rate cut, but it could weaken further if financial markets begin to price-in even further action from the RBNZ for subsequent months.

The Kiwi currency is already down 2.8% against the U.S. Dollar this year but most analysts see only limited scope for further losses before year-end. The Pound-to-New-Zealand-Dollar rate has already gained 2.35% in 2019 but many say it could go much higher still if the Brexit standoff is resolved amicably.

"UK political uncertainty has risen following PM May’s resignation. The new leader, and implications for Brexit, will be key for GBP. Three months ahead: Binary– either we get a friendly Brexit which would push NZD/GBP below 0.5000 by year end, or it’s hostile and we see 0.5500. We are leaning towards the former," Speizer adds.

Speizer says a 'hostile Brexit' could push the Pound-to-Kiwi rate all the way down to 1.81 but that an ammicable EU exit for the UK could see the exchange rate rise to 2.0 before year-end.

Above: Pound-to-New-Zealand-Dollar rate shown at daily intervals.

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