New Zealand Dollar Tops G10 after Inflation Bounce Lengthens Odds of August RBNZ Cut

© Filipe Frazao, Adobe Stock

- NZD tops G10 as CPI data impairs odds of 2nd RBNZ cut.  

- ANZ fingers petrol prices, says CPI strength is temporary.

- Local analysts still look for Aug and Nov cuts from RBNZ.

- NZD outlook still depends heavily on USD, Fed fortunes.

- GBPNZD heads for new lows as Brexit fears rattle again.

The New Zealand Dollar advanced to the top of the G10 league table Tuesday after a bounce in the official measure of inflation saw market expectations of an August interest rate cut from the Reserve Bank of New Zealand (RBNZ) ebb, although local analysts have not been swayed by the prices data. 

New Zealand inflation was 0.6% during the second quarter, which was unchanged from in the opening quarter although that number was enough to lift the annualised rate of inflation from 1.5% to 1.7%. 

"NZD is top performer. Q2 NZ inflation was in line with expectations but NZD has taken it well, with 1.7%y/y somewhat undermining expectations of an August cut," says Elsa Lignos, head of FX strategy at RBC Capital Markets. 

So-called underlying inflation was higher than the 1.7% headline number in the recent quarter, with Statistics New Zealand's various measures of 'trimmed mean' inflation ranging between 1.9% and 2.1% for the year to the end of June. 

Above: Contributions to New Zealand inflation. Source: Statistics New Zealand. 

The trimmed mean measures exclude the most volatile items, which are often energy products or other commoditised goods, from the basket measured and so are said to provide a better reflection of the underlying trend in prices. 

"The New Zealand dollar has been the top performing G10 currency overnight as 2Q core inflation accelerated by 1.7% year-on-year (vs 1.5% previously), in line with market expectations. For today, this is positive for the NZD as it should keep local rates supportive, partly offsetting the expected stronger US dollar dynamics coming from the US data later today," says Petr Krpata at ING. 

Markets care about inflation because it dictates Reserve Bank interest rate policy, which has significant influence over international capital flows as well as speculative short-term trading activity. 

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

Above: New Zealand Dollar performance Vs G10 on Tuesday. Source: Pound Sterling Live. 

"It looks like Q2 CPI is as good as it will get for domestic inflation for some time," says Michael Callaghan at Australia & New Zealand Banking Group. "There is nothing in today’s release for the RBNZ to get excited about. Today’s print for CPI inflation was in line with the 0.6% q/q rise incorporated in the RBNZ’s May MPS. But petrol prices are volatile and recent strength will drop out of headline inflation in time."

The Reserve Bank of New Zealand is obliged to use interest rate policy to ensure inflation remains within the 2%-to-3% target band over the medium term. The bank cut its interest rate to a fresh record low of 1.5% in May, citing years of below-target price pressures and an economic outlook, which has been dented by the U.S.-China trade war, that is now insufficient to support a sustainable increase of inflation into the target band.

Tuesday's data has briefly enabled financial markets to relax about the prospect of further imminent interest rate cuts from the RBNZ, although analysts at both ANZ and Commonwealth Bank of Australia (CBA) are saying New Zealand's policymakers will still slash borrowing costs for companies and consumers again in August. They also say a further 0.25% cut will take the cash rate to 1% in November 2019. 

"There were some signs of cost increases such as household contents and services.  But, on the whole, New Zealand inflation remains soft," says Joseph Capurso at CBA. "Our ASB colleagues still expect the RBNZ to cut the official cash rate by a further 25bp in August and November to take the cash rate to a record low of 1.0%."

Above: NZD/USD at daily intervals.

The New Zealand Dollar was top of the G10 leader-board Tuesday but the outlook for the currency depends as much on what happens in the U.S. as it does developments on home shores. Markets have come close to having fully 'priced in' further rate cuts from the RBNZ but also a series of cuts from the U.S. Federal Reserve. 

Whether the Kiwi continues the recovery that took hold in the second quarter depends in large part on whether the Fed goes ahead and indulges the market at the end of July and again in September. If it disappoints the market then the Kiwi's newfound recovery could be undermined. 

"The RBNZ was the first G10 central bank to cut rates this cycle and it has warned that more stimulus is in the pipeline, with August widely expected to bring a policy move," says Jane Foley, head of FX strategy at Rabobank. "While NZD/USD has found some support from Fed rate cut expectations, we see downside potential medium-term on risk of an escalation in China/US trade wars and a broad decline in risk appetite."

The Pound-to-New-Zealand-Dollar rate has now fallen more than 2% for 2019 due to mounting concerns in the market that Boris Johnson, who'll become Prime Minister if succesful in his Conservative Party leadership campaign this month, will eventually lead the UK out of the EU without having signed the withdrawal agreement. 

Fears of this 'no deal' Brexit have driven Pound Sterling from second place in the G10 league table for 2019 at the beginning of May to second-from-last place on Tuesday, with the catalyst for losses being the resignation of Prime Minister Theresa May in the month of May. 

Many in the market say Pound Sterling will wrack up further notable losses before the October 31 deadline that marks the expiry of the current Article 50 extension period, but Rabobank's Foley forecasts renewed losses will take the NZD/USD rate down to 0.64 by year-end and a notable recovery for the Pound-to-Kiwi rate up to 2.03.

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

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