New Zealand Dollar Forecast to Firm from Here but threat of RBNZ Interest Rate Cut Could Scupper the Currency

- NZD has bottomed out after pricing dovish RBNZ rate path.

- Scope for a modest 2018/19 recovery say multiple analysts.

- But this is hinged on RBNZ avoiding a rate cut in early 2019.

© Filipe Frazao, Adobe Stock

The New Zealand Dollar has fallen as low as it is likely to go and could recover steadily over coming months, according to multiple analysts covering the currency, although mounting fears of a possible interest rate cut mean the currency will remain a developed world underperformer.

New Zealand's Dollar has fallen more than 5% against the US Dollar and Japanese Yen in 2018 while also notching up heavy losses against the Swiss Franc, Euro and Canadian Dollar. It has declined less than 1% against the Brexit-battered Pound Sterling.

This was after financial markets gave up all remaining hope of a Reserve Bank of New Zealand interest rate rise this year, which could have offset some of the pressure that rising rates elsewhere in the world have wrought on the currency, and shifted to pricing in the mounting prospect of an interest rate cut. 

Investor angst over the US government's trade policies have also weighed on the Kiwi currency due to it being underwritten by commodity exports and exposed to the ebb and flow of Chinese economic growth, which is under threat from the "trade war" between the US and China.

"The market quickly moved to price in the RBNZ’s new monetary policy path, therefore the drag on the Kiwi from lower policy rate expectations has likely run its course," says Fiona Lake, a strategist at UBS. "Our RBNZ policy expectations are more hawkish than the market, which points to modest Kiwi appreciation. 

RBNZ governor Adrian Orr said in August that Kiwi interest rates are likely to remain at a record low of 1.75% until well into the third quarter of 2020 when, until then, markets had been looking for a rate hike some time around the middle of 2019. This dealt another blow to the New Zealand Dollar.  

Above: NZD/USD rate shown at daily intervals.

Pricing in interest rate derivatives markets, which enable investors to protect themselves against changes in interest rates while providing insight into monetary policy, implies a cash rate below the current 1.75% until February 2019. For the 08 May, 2019 meeting the implied cash rate was just 1.67% on Wednesday morning, down from 2.15% on December 29.  

"We think that reaccelerating growth, unchanged unemployment and rising CPI inflation means the RBNZ will not be a position to cut anytime soon. However, the RBNZ will likely want to keep the risk of a cut alive. It will be interesting to see if the RBNZ acts quickly to talk down any renewed rate hike expectations, should they emerge," says UBS' Lake.

Fears of a rate cut have been encouraged by the RBNZ's deputy governor John McDermott, who said in an interview earlier in August the odds of such a move have increased this year.

Some domestic lenders, including Westpac and Kiwibank, have already begun slashing their mortgage rates in recent weeks.

UBS' Lake and other analysts say whether or not the bank goes ahead with a rate cut will depend heavily on the third-quarter GDP report, which is due for release in December.

Kiwi economic growth slowed to an annualised pace of 2.7% in the first quarter, down from 2.9% previously, and RBNZ forecasts suggest could fall as low as 2.3% for the second quarter before recovering in the third. Second quarter GDP data will be released late in September. 

"If growth slows from here or does not materially pick up – Q2 GDP is released 20 September and our tracking is +0.7%/q compared to the RBNZ at +0.5%/q – then the market can be expected to mark higher the probability that the next move in the OCR is down. At the moment OIS is 33% priced for a cut by May 2019," says Annette Beacher, chief Asia Pacific macro strategist at TD Securities. 

UBS' Lake says the Kiwi economy should have grown at a quarterly pace of 0.5% for the three months to the end of June, which is in line RBNZ forecast, before picking up to 0.7% in the third quarter.  

However, the RBNZ is hoping to see quarterly growth of 0.8% during the three months to the end of September.

This could leave the odds of a rate cut finely balanced going into the New Year. 

Above: Pound-to-New-Zealand-Dollar rate shown at daily intervals.

All of the growth forecasts matter because of the impact that rising and falling demand within an economy can have on inflation. It is inflation that central banks are attempting to manipulate when they tinker with interest rates, and Kiwi inflation has remained stubbornly below the midpoint of the RBNZ's 1% to 3% target band for much of the time since 2012. 

"The money markets are pricing in a small probability of rate cuts over the next year in response to a dovish RBNZ. We think this is premature and do not see rate-cut expectations increasing unless growth disappoints significantly. We do not expect further NZD weakness, although trade tensions and USD strength may prevent a short-term recovery in NZD-USD," says Mayank Mishra, a strategist at Standard Chartered.

Mishra and the Standard Chartered team say the NZD/USD rate should trade close to 0.66 around the end of 2018 and that it is expected to rise back toward 0.74 throughout 2019.

Lake and the UBS team forecast an NZD/USD rate of 0.69 for December 2018 and a recovery to 0.72 in 2019.

Both sets of forecasts are hinged on the RBNZ avoiding a rate cut in the months ahead.

Lake predicts and RBNZ rate rise in November 2019 while Mishra's call is for a rate hike in "Q4-2019".

TD's Beacher also has a rate hike pencilled in for November 2019.

The NZD/USD rate was quoted 0.17% lower at 0.6704 during the London session Wednesday while the Pound-to-New-Zealand-Dollar rate was 0.37% higher at 1.9240.

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