Why the New Zealand Dollar Rose After Softer-than-Expected Inflation Data

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The New Zealand Dollar tops the leaderboard in the wake of the release of much-anticipated inflation data that shows prices continue to rise sharply, but not quite as fast as the market had been expecting.

CPI inflation rose 6.9% year-on-year in the first quarter said StatsNZ, up from the previous' quarter's 5.9%, but below the 7.1% expected by markets.

Inflation rose 1.8% quarter-on-quarter in Q1, which was more than Q4 2021's 1.4% increase but again it came in below analyst expectations for a reading of
2.0%.

The New Zealand Dollar's reaction might seem curious at first as data shows it to be the best performing currency in the G10 in the hours following the release:

Above: The NZ Dollar tops the leaderboard on April 21.

The long-standing rule of thumb in global forex is that a currency falls in response to inflation that underwhelms against investor expectations.

But, in 2022 the world is in a different place to where it has been for much of the previous two decades: inflation is surging to economically destructive levels.

Indeed, today's inflation represents the hottest reading in 32 years for New Zealand.

One analyst explains the Reserve Bank of New Zealand (RBNZ) would have to hike rates even further and faster in the event inflation starts smashing expectations, which in turn adds significant headwinds to economic growth.

"Investors are beginning to become concerned that the RBNZ may crush NZ’s economic recovery before it can tame inflation. Thursday’s inflation reading will therefore potentially have conflicting impacts on the NZD," says Valentin Marinov, Head of FX Strategy at Crédit Agricole.

The latest inflation readings nevertheless bolster the case for the RBNZ to raise interest rates further, offering ongoing yield support to the New Zealand Dollar.

Markets expect the RBNZ to hike by another 50bps at the May meeting, but from there some analysts say the RBNZ can afford to pause until August.

Marinov says investor expectations of the RBNZ becoming more aggressive would have been boosted had inflation come in stronger-than-expected.

"It could also lead to curve flattening as investors build in a greater risk of NZ’s economic recovery being snuffed out by the RBNZ," says Marinov.

This refers to a scenario where interest rate futures signal higher interest rates in the near-term but falling rates in the longer-term which suggests investors see growth slowing notably.

This is partly because a series of aggressive rate hikes now can harm growth later, leading the central bank to ultimately reverse some of those hikes.

Because inflation is hot, but not searingly hot, the market sees New Zealand's interest rates rising steadily in a manner that is not yet destructive of the economy's growth potential.

This is on balance supportive of the New Zealand Dollar.