New Zealand Dollar Rally Pushes GBP/NZD to July Lows Ahead of NZ CPI

"These are important developments as they suggest households are looking through the current period of inflation and have confidence that it will head lower with lower gasoline prices the likely instigator," - James Knightley, chief international economist at ING. 

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The New Zealand Dollar and other currencies rallied ahead of the weekend as financial markets responded to surprisingly strong U.S. economic figures and soothing remarks from Federal Reserve officials, all of which appeared to help push GBP/NZD close to six week lows.

New Zealand’s Dollar rallied while the U.S. Dollar fell broadly on Friday following a flurry of U.S. economic data that may have eased recent concerns about the risk of a recession, aided by Fed officials who appeared to throw cold water over recently escalating market expectations for U.S. interest rates.

There was, meanwhile, a clear underperformance by Sterling that almost inevitably served to exacerbate the Friday decline in GBP/NZD.

“The good news for the Fed is that inflation expectations for the next five-to-10 years dipped three tenths to 2.8%, the lowest since July last year, but this initial estimate is not reliable,” says Ian Shepherdson, chief economist at Pantheon Macroeconomics, in reference to a University of Michigan survey.

“The measure is sensitive to food and energy prices, like other survey-based measures of consumer inflation expectations, so we expect it to dip over the next couple months. Still, the initial July reading looks good,” he added.

Above: Pound to New Zealand Dollar rate shown at hourly intervals alongside NZD/USD.

The preliminary University of Michigan Consumer Sentiment index rose from 50 to 50.1 for the month of July on Friday, surprising on the upside of market expectations that had looked for it to decline further, while the survey also showed consumers' long-term inflation expectations retreating. 

"These are important developments as they suggest households are looking through the current period of inflation and have confidence that it will head lower with lower gasoline prices the likely instigator," says James Knightley, chief international economist at ING. 

Falling inflation expectations could be welcomed by Federal Reserve officials who in recent days have appeared to push back against the notion that the bank could be likely to lift its interest rate by a full percentage point later in July and due to the inflation figures released in the U.S. on Wednesday. 

Financial markets shifted to price-in a high probability of a 100 basis point increase in the Fed Funds rate, weighing heavily on risky assets and currencies, after the June inflation data appeared to suggest that the road back to the Fed’s 2% target could be a long and arduous one.

"It has been a volatile week for interest rate expectations ahead of the July 27th FOMC meeting, but the final sets of data showing reasonable retail sales yet falling inflation expectations, lower import price inflation and the second consecutive fall in manufacturing suggests a 75bp hike is the most likely outcome," Knightley also said on Friday.

Above: Pound to New Zealand Dollar rate shown at daily intervals alongside NZD/USD.

Separately on Friday, the Empire State Manufacturing Index confounded market expectations when rebounding from -1.2 in June to 11.1 for July and Census Bureau figures suggested that retail sales rose strongly in June.

"Much of the advance owes to higher prices. The 1.0% growth in total sales was a tick above the consensus, and added to a positive revision to the prior month," says Katherine Judge, an economist at CIBC Capital Markets. 

Friday's U.S. data comes ahead of Monday's second quarter inflation figures from New Zealand, which is the highlight of the week ahead for the Kiwi and could influence the Reserve Bank of New Zealand (RBNZ) interest rate outlook.

The RBNZ raised its cash rate for a fifth time on Wednesday when lifting it from 2% to 2.5%, the third time it has used a 0.5% increment.

“New Zealand’s inflation problem isn’t as bad as in the US (and hopefully that remains the case) – but it’s still far too high (and forecast to increase a touch further) No surprises then that the RBNZ delivered a third 50bp rate hike," says Sharon Zollner, chief economist at ANZ.

“Next week we get the numbers for Q2 CPI inflation. We’re expecting annual CPI inflation lifted to 7.1% y/y (versus 6.9% in Q1). It’s unlikely to deter the RBNZ from a fourth 50bp rate hike in August – and any upside surprises only increase the odds of further 50bp hikes beyond August,” Zollner added.