New Zealand Dollar: GDP Beats Expectations but Third-quarter is Now Crucial to Outlook

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- NZD rises as GDP growth picks up in second-quarter.  

- Data eases fears over possible RBNZ interest rate cut. 

- All eyes now turn to crucial third quarter growth number.

The New Zealand Dollar rose broadly Thursday after official data showed Kiwi GDP growth picking up during the second-quarter, delivering a rebuke to Reserve Bank of New Zealand (RBNZ) concerns the economy is slowing and that an interest rate cut might be necessary in the near future.

New Zealand's economy grew by 1% during the three months to the end of June which, up from 0.5% at the beginning of the year, was more than twice the 0.5% expansion the RBNZ had forecast. This pushed the annualised pace of growth up from 2.6% to 2.7% for the second quarter when markets had looked for a decline to 2.5%.  

Statistics New Zealand says 15 out of a total of 16 industries grew during the recent quarter, with just the mining sector experiencing a decline, helping spur the economy onto its best quarterly performance for nearly two years. The services industry was the best performer for the period, although agriculture, fishing and forestry also did well too. 

"Not only was the overall result stronger than expected, the details were more encouraging for the economy’s growth prospects going forward," says Michael Gordon, an economist at Westpac. "Growth was shared widely across the economy, and the one-offs – in areas such as electricity, transport and government services – weren’t as big as we expected, which means there’s less risk of an unwind in the next quarter."

Gordon notes there were also some negative "one-off" factors that had an adverse impact on Thursday's data, such as a maintenance shutdown at a key oil refinery and an unplanned shutdown that hit the gas energy sector, which could be reversed in the third quarter and support growth for that period. He estimates those adverse one-offs shaved 0.2% from New Zealand's GDP this time around.  

"Today’s result doesn’t guarantee that the economy is on an accelerating path, but it does argue against the case for OCR cuts in the near future," the economist concludes.

The NZD/USD rate was quoted 0.15% higher at 0.6651 during early trading Thursday although the Pound-to-New-Zealand-Dollar rate was up 0.09% at 1.9801. The Kiwi was also higher against all other G10 currencies except the Japanese Yen. 

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Currency markets care about the GDP data because it reflects rising and falling demand within the economy, which has a direct bearing on the consumer price inflation that is so important for questions around interest rates. And interest rates themselves are a raison d'être for most moves in exchange rates.

Changes in rates, or hints of them being in the cards, are only made in response to movements in inflation but impact currencies because of the push and pull influence they have on capital flows and their allure for investors.

"NZD/USD is likely to lift further over coming days as interest rate markets continue to adjust marginally higher. It would appear appropriate that the OIS market reduce the possibility of an RBNZ rate cut because the guidance given by the RBNZ governor surrounding the risk of a rate cut were based on the chnace of New Zealand GDP plummeting," says Joseph Capurso, a senior currency strategist at Commonwealth Bank of Australia.

Thursday's data is significant because RBNZ officials said in August the odds of an interest rate cut have increased this year. This came after RBNZ governor said in both August and July that interest rates would not rise for "quite some time to come".

The RBNZ interventions dealt a blow to the Kiwi, helping it fall to an 8% 2018 loss against the U.S. Dollar and 5% decline against Sterling in August, because until then markets had looked for the central bank to lift its cash rate from the current record low of 1.75% around the middle of 2019.

"Our ASB colleagues maintain an early estimate of 0.6% for New Zealand's Q3 real GDP growth, suggesting growth won't be plummeting despite the decline in business confidence," Capurso concludes. 

Improving Global Sentiment Lifts Kiwi

The New Zealand Dollar has outperformed this week, alongside the Australian Dollar, in response to market relief that President Donald Trump's latest move in the "trade war" with China was not as severe as it could have been.

Sentiment toward the China-exposed Antipodean currencies was further boosted Wednesday after Premier Li Keqiang said the world's second largest economy will not weaken its currency in order to offset the impact of President Trump's latest tariffs. The closely-correlated Renmimbi and Kiwi both rose in response.   

"We are often asked whether one currency’s performance could be a ‘leading indicator’ for the global economic cycle. Guided mostly by backward-looking economic data, markets are always looking for a ‘canary’ in the coalmine of global growth," says David Bloom, head of currency research at HSBC. "A dive into the data adds to the view that the NZD’s weakness could be a signal of a broader malaise."

Bloom says New Zealand's Dollar, alongside the Korean Won, are good barometers of sentiment toward the global economy because of their exposure to global trade flows and the fact that both are underwritten by small, open economies. Noting that the Kiwi bond market is pricing in a mounting possibility of an interest rate cut over coming months, he observes that there could be more to the New Zealand Dollar's dire 2018 performance than simple fears over the domestic economy.

In fact, that dire performance has been accompanied by outperformance in the Kiwi bond market as traders bet the RBNZ will soon slash its interest rate. And Bloom says New Zealand bond prices did a good job of predicting global economic downturns in 2007, 2010 and 2014. They also lead the way in flagging eventual economic recoveries in 2008, 2012 and 2016. HSBC research finds Kiwi bonds often frontrun a broader move in global markets by as much as four months. 

"Viewed in this context the recent move to price in a possibility of RBNZ easing – as much as 10bp by the middle of next year – should not be ignored. For kiwi watchers, the near-term outlook for the NZD hinges somewhat on the Q2 GDP print. Yet, given the RBNZ has signalled it may cut by as much as 100bps if growth remains slow, a disappointing print could have a wider significance for financial markets," Bloom writes, in HSBC's latest currency market outlook. 

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