New Zealand Dollar is the Star Performer as NZ Inflation Jumps

Currencies tend to move higher when inflation moves higher. This rule was applied to the New Zealand Dollar on April 20 when it jumped in response to news New Zealand’s annualised inflation rate had risen to 2.2%.

Markets had only expected a reading of 2.0% to be released but Statistics New Zealand produced a shock when they showed inflation was now running at a five-year high. The quarterly inflation figure read at 1.0%, well above the 0.8% forecast by analysts.

The Pound to New Zealand Dollar exchange rate fell down to 1.1890 following the release having been as high as 1.8349 earlier in the week.

The New Zealand Dollar to US Dollar exchange rate traded up to 0.7042 having been as low 0.6996 earlier in the week.

Why is inflation positive for the New Zealand Dollar?

Central banks tend to fight inflation by raising interest rates - this tends to slow the flow of money around the economy and bring prices down. But, higher interest rates also attract foreign investor flows which in turn bids up the currency.

“The odds that the RBNZ's easing cycle is over have grown, and enough for our NZ economists to remove the final cut in their profile,” says Michael Turner at the Royal Bank of Canada in Sydney.

Some of the more volatile components have been important in pushing headline rates higher in recent quarters, though various measures of underlying inflation have also quickened.  

“With indicators of real activity remaining firm, the RBNZ may struggle to cling to its (weak) easing bias in next month's MPS,” says Turner.

Rising petrol prices along with the annual rise in cigarette and tobacco tax lifted inflation," prices senior manager Jason Attewell at Statistics New Zealand said. "Petrol prices in New Zealand are closely linked to global oil prices, and cigarettes and tobacco taxes rise in the March quarter each year".

Annual inflation is now at its highest point in five years, the RBNZ cannot sit back and pretend further interest rates are warranted when faced with such data.

“The NZD trade weighted index is weaker than what the RBNZ had forecast earlier this year in February. As a result, financial markets have increased the odds (32%) that the RBNZ will raise the Official Cash Rate by the end of this year,” says Roy Teo, a foreign exchange strategist with ABN AMRO Bank.

ABN AMRO say they acknowledge that recent developments have challenged their view that the RBNZ is likely to only tighten monetary policy early next year.

However in the next monetary policy meeting on 11 May, ABN AMRO expect the RBNZ to highlight that the subdued labour market and wage growth as a reflection of spare capacity in the economy.

Note too that the impact of food and petrol price gains are likely to be temporary and there remain plenty of questions surrounding the global inflationary backdrop.

"It is certainly not guaranteed that headline inflation remains around current levels for a sustained period," says Cameron Bagrie Chief Economist at ANZ Bank.

However, today’s data reinforces ANZ's view that the next move in the OCR will be up.

While acknowledging the uplift in some core inflation gauges, we doubt there is enough evidence in the breadth of moves to spur the RBNZ into shifting its stance just yet,

In addition, there are some encouraging signs that house price inflation has probably peaked and hence the spill over effects on non-tradable inflation will slow.

“Nevertheless, we expect the NZD to be supported as overcrowded net short speculative positions are unwound given an improving inflation and terms of trade outlook,” says Teo.