Why The New Zealand Dollar Rally Has Further To Go

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The New Zealand Dollar was the best-performing major currency through the midweek session as it looks set to extend a month-long period of outperformance.

The Pound to New Zealand Dollar exchange rate is now poised for a test of the key support level of 2.03 after the Kiwi was boosted by a recalibration in expectations for Reserve Bank of New Zealand monetary policy, with markets increasingly expectant the central bank will raise interest rates again.

The 2.03 area is where the August-October selloff failed, resulting in GBPNZD consolidation ahead of a rebound that has all but been reversed as year-end approaches.

NZDUSD is holding its November-December uptrend at 0.6147, with the recent retracement from the 0.62 peak hardly a bother at this stage. "The Kiwi’s firm rejection above 0.6200 fits with our previous suspicion that it was getting technically stretched. We would still consider buying dips, with potential for a test of 0.6300 by mid-December," says Martin Whetton, a strategist at Westpac.

Gains against the Euro are more pronounced, with the Euro to New Zealand Dollar exchange rate now probing below the key 1.7538 support zone. A break here opens the door to levels not seen since mid-year in the 1.73-1.74 zone.

The Euro is particularly vulnerable to the NZ Dollar's rally owing to the rise in expectations that the European Central Bank stands ready to cut interest rates by as early as April 2024.

By contrast, the NZD was boosted by last week's RBNZ policy update, where policymakers said further rates are likely owing to persistent inflationary pressures.

"The message from the RBNZ is that it seems to have little tolerance of upside inflationary surprises," says Doug Steel, an analyst at BNZ. "It wouldn’t take much for the RBNZ to follow through with an actual hike."

Crucially, this pushed back market expectations for the amount and timing of rate cuts the RBNZ could deliver in 2024. "It would take a fair bit of downside surprise before the Bank would contemplate reducing the OCR anytime soon," says Steel.

Above: NZD is the top-performing G10 of the past month. Track NZD with your own custom rate alerts. Set Up Here.

"There are good reasons for the RBNZ to be worried and impatient, but also solid signs of progress in the inflation battle. Weighing it up, the RBNZ’s November MPS signalled a low bar to further hikes," says Sharon Zollner, Chief Economist at ANZ.

The NZD has risen against all its G10 peers over the course of the past month, aided by a broad improvement in global risk sentiment and expectations that the worst of the Chinese economic slowdown has passed.

"The month-old rally has mostly been driven by softer U.S. data and some dovish and less-hawkish Fedspeak recently," says Westpac's Whetton.

Global stocks booked their biggest monthly rally in three years - the MSCI All-Country World index rose 9% in November - as investors bet the Federal Reserve and other big central banks will pivot to rate cuts over the coming months as they are close to winning the battle with inflation.

Looking ahead, the NZD rally will require these supportive global tailwinds to extend, but the outperformance will also require a firming in expectations for higher New Zealand interest rates.

ANZ says if the RBNZ hikes again, it would do so more than once, making this the most 'hawkish' of the G10 central banks heading into the new year.

Above: Expectations for future NZ rates have actually lifted since November, whereas they have fallen in other G10s. Image courtesy of Goldman Sachs.

"The RBNZ seems unlikely to kickstart the hiking machine again for the sake of just 25bps, as if that’s all that’s perceived to be needed," says Zollner.

"Unless the facts change (always a live possibility!), if the RBNZ does hike in February (or after that), chances are they’ll go again," she adds.