New Zealand Dollar Outperforms after RBNZ Leaves Rate Cut Punters Empty Handed 

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- NZD claims 1st place in G10 after RBNZ's June interest rate decision.

- RBNZ neglects to indulge rate cut bets but market still eyes August cut.

- CBA says ANZ business confidence data could hurt NZD Wednesday.

The New Zealand Dollar outperformed its developed world rivals Wednesday after Reserve Bank of New Zealand (RBNZ) Governor Adrian Orr said little in the bank's latest policy statement to suggest that a further interest rate cut is imminent, disappointing those in the market who'd bet it would cut again. 

New Zealand's Dollar was riding high at the top of the G10 league table and carrying a notable gain over Pound Sterling and the U.S. Dollar after Governor Adrian Orr said only that a "lower [cash rate] may be needed over time" as guidance for markets. It goes almost without saying the RBNZ left its cash rate unchanged at 1.5% Wednesday.

"We expect low interest rates and increased government spending to support a lift in economic growth and employment. Inflation is expected to rise to the 2 percent mid-point of our target range, and employment to remain near its maximum sustainable level. Given the downside risks around the employment and inflation outlook, a lower OCR may be needed," Orr says in a statement.

Pricing in the overnight-index-swap market had implied an RBNZ cash rate of just 1.45% for Wednesday 26, June, suggesting that some investors were betting on a rate cut at this month's meeting. Enough of them to give such a thing a 20% implied probability, but rate cut speculators were left empty handed.

Above: New Zealand Dollar performance Vs G10 rivals Wednesday.

The RBNZ cut its cash rate to a new record low of 1.50% in May, citing below-target inflation and an economic outlook that is insufficient to encourage a return of the consumer price index above the midpoint of the 1%-to-3% target band.

"Ahead of the announcement, markets had priced a 20% chance of a cut today, and a 90% chance of a cut by August. The chance of a cut in August is now at 75%," says Imre Speizer at Westpac. "Given the tone of this statement from the RBNZ, we remain of the view that the RBNZ will most likely cut the OCR in August. The repeated comment that a lower OCR may be needed is blunter than the language used in March, which was followed by a cut in May."

The global and New Zealand economies are slowing in the face of President Donald Trump's trade war with China and after more than a year of steep Federal Reserve interest rate hikes, which have drawn capital from the rest of the world and into the U.S., leading to a tightening of 'liquidity' and raising funding costs for some countries. 

This is a problem for the RBNZ because inflation has already been below the midpoint of the 1%-to-3% target for substantially all of the last five years and getting price pressures back to the target level requires faster economic growth. 

"Given the fact that money markets are pricing a 76% chance of a rate cut in August, the gain in NZD and interest rates will likely prove temporary," says Kim Mundy, a currency strategist at Commonwealth Bank of Australia. "In fact, NZD and NZ interest rates could fall as soon as tonight following the June ANZ business confidence release (2am London).  The RBNZ statement noted that soft business confidence is dampening domestic spending. The risk is that tonight’s ANZ business confidence release remains weak."

Changes in rates are only normally made in response to movements in inflation, which is sensitive to economic growth, but impact currencies because of the influence they have on capital flows and their allure for short-term speculators.

Capital flows tend to move in the direction of the most advantageous or improving returns, with a threat of lower rates normally seeing investors driven out of and deterred away from a currency. Rising rates have the opposite effect.

"Importantly, despite the dovish turn by the Fed, the NZD TWI has only appreciated 1.4%,and the 2Q average is 0.8% weaker than the RBNZ's forecast, suggesting little pressure for them to act to prevent FX appreciation from weakening the inflation outlook," says Hans Redeker, head of FX strategy at Morgan Stanley. 

Some analysts had suggested the RBNZ might want to cut interest rates as soon as Wednesday, or at the very least attempt to talk the New Zealand Dollar lower, because the Kiwi has been on the verge of an unhelpful rally ever since last Wednesday when the U.S. Federal Reserve signalled a landmark shift in its own interest rate policy. 

A stronger currency can reduce inflation by making imported goods cheaper to buy. And there are  plenty of central banks who've already cut their own interest rates or are on the verge of doing so, including the Fed, the European Central Bank and the Reserve Bank of Australia. RBA Governor Philip Lowe noted Monday that he is having to contend with this new dynamic.

The Pound-to-New-Zealand-Dollar rate was quoted 0.68% lower at 1.9001 during the morning session Wednesday and is now up just 0.29% for 2019, while the NZD/USD rate was 0.52% higher but is down 0.64% this year. 

Above: NZD/USD rate shown at daily intervals.

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