New Zealand Dollar Steams Ahead in Wake of RBNZ Housing Shift

- NZD on the front foot
- NZ govt. tells RBNZ to focus on house prices
- Investors reckon this means higher rates in the future
- Comes days after RBNZ triggers bout of NZD strength

Above: File image of Grant Robertson. Picture credit: TEU Annual Conference, sourced Flickr, reproduced under CC licensing conditions.

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The New Zealand Dollar could prove unstoppable in the short-term as markets adjust to a view that the Reserve Bank of New Zealand (RBNZ) has switched from being a headwind, as was the case in 2020, to an outright source of support.

The RBNZ was instructed by the New Zealand government on Thursday Feb. 25 to consider the impact on housing when making monetary and financial policy decisions, a development investors saw as being conducive to higher interest rate settings in the future owing to New Zealand's 'hot' property market.

In the wake of the developments, the yield paid on New Zealand ten year bonds surged by 18 basis points to 1.87%, a move that only attracted investors into Kiwi assets and built up a fresh new bid for the New Zealand Dollar.

The move higher in yields is a signal by the market that they expect higher interest rates in the future, not lower rates.

The foreign exchange playbook says a currency appreciates when interest rate expectations rise relative to those elsewhere.

Hence, the New Zealand Dollar's reaction: The NZD/USD exchange rate rallied by 1.30% on the announcement and subsequent gains take the exchange rate to new three-year highs at 0.7455. The Pound-to-New Zealand Dollar exchange rate (GBP/NZD) meanwhile fell 1.0% and is holding levels around 1.90.

Finance Minister Grant Robertson told the RBNZ that it will need to explain regularly how it has sought to assess the impacts on housing outcomes.

"Soaring house prices have been high on the New Zealand government's agenda," says Carol Kong, Associate International Economist and Currency Strategist at Commonwealth Bank of Australia. "The RBNZ must now also consider the effects of its monetary policy decisions on the government’s housing policies (i.e. slow house price growth)."

Employment and inflation will remain the primary objectives of monetary policy and if there is a conflict say economists at Kiwi lender ASB, who believe employment/inflation will win out.

The addition of house prices to the monetary policy remit does complicate the RBNZ’s future policy responses and communications.

ASB also see a high chance restrictions on debt-to-income ratios and/or interest-only mortgages will be introduced this year given the RBNZ will struggle to justify raising rates given the acute risks to growth posed by covid-19.

The developments concerning the housing market come a day after the RBNZ prompted New Zealand Dollar strength by sitting on its hands at the February policy decision.

The RBNZ had been tipped by some analysts to take the fight to a strengthening New Zealand Dollar, which they saw as working against the RBNZ's efforts to stimulate domestic growth and inflation.

The Bank attempted to send some "dovish" guidance to the market by signalling the need for prolonged monetary support, but they also upgraded projections for GDP and employment.

The market is therefore of the belief that further rate cuts and additional boosts to quantitative easing - expectations that drove the NZ Dollar lower in 2020 - are a now a thing of the past.

"The RBNZ will hardly curb NZD upside," says Francesco Pesole, a strategist at ING. "When compared to the neighbouring Reserve Bank of Australia, the RBNZ message was less dovish - for example, it fell short of matching the date-contingent (2024) RBA forward guidance – which should, in our view, leave wider room for markets to speculate about RBNZ tapering in the coming months."

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Tapering is a financial colloquialism for the ending of monetary support by exiting an existing quantitative easing programme.

Meanwhile, global commodity prices maintain a robust appreciation trend, which tends to benefit the commodity-linked currency bloc which includes the Aussie and Kiwi Dollars.

"The commodity-related currencies continue to benefit from building confidence in the outlook for the economic recovery. It has been notable that global activity data has continued to surprise to the upside at the start of this year in spite of the COVID-related restrictions that have been in place over the winter. It suggests that global economies have been adapting better than expected which is helping to dampen downside risks to growth," says Lee Hardman, Currency Analyst at MUFG.