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Interest Rate Market Commentaries - Weekly

There was a surprise in last week’s 0.0% inflation numbers for the June that no-one picked. The significant reduction in communication prices has continued over the last 12 months, and these price decreases appear to be the only factor keeping annual inflation so low. The question going forward has to be for how long can falling household internet and mobile costs continue? I have always said that fierce competition in the economy is the best way to maintain low inflation. However, you do wonder about for how long the squeezed profitability margins at the three mobile service providers can go on for. We will see if the RBNZ address this sort of inflation analysis in their 10 August statement.

The financial markets will be looking closely at the RBNZ’s update inflation forecasts in the 10 August Monetary Policy Statement. The NZ dollar exchange rate has traded substantially above their assumed level for this time, therefore they must be forced to reduce their March 2018 inflation forecast to below 1.00%. It takes nine months for higher exchange rate movements to feed through to lower imported goods prices. The RBNZ will not be too happy that miss-placed statements about interest rates by their mates over at the RBA over recent weeks has sent both the Aussie and Kiwi dollar’s higher against the USD.

NZ Exchange Rate Commentary

Australian driven NZD surge

The art of central banking revolves around understanding in advance how the financial markets will react to any statement/report that is produced. Over recent weeks the Reserve Bank of Australia (RBA) has failed that first principle of monetary policy management. In sending an unqualified message to the markets that the long-term/equilibrium average for the Australian OCR interest rate was 3.5% (currently 1.50%), the RBA was not intending to signal a desired tightening in monetary conditions at this time. However, this is exactly what the markets interpreted from the statement and the Aussie dollar shot higher. Last week the RBA were forced in a series of speeches by their Assistant Governors to clarify their messaging in an attempt to take the heat out of the currency appreciation.

It is far too early for the RBA to be even mentioning in end to their loose monetary policy settings and they did not intend to convey that message. Over recent months the RBA have been very clear in the statements to the market that an AUD/USD exchange rate above 0.7700 was inconsistent against their economic fundamentals, mining commodity prices in particular. With the Aussie dollar now trading above 0.7900, the RBA have their work cut out to dissuade speculative buying of the currency as global FX players look for an alternative currency out of the weakening US dollar. Whilst there has been some recovery in metal and mining commodity prices of late, the AUD has appreciated much more than the commodity price lift.

The dramatic breaking of the previous resistance at 0.7700 in the AUD/USD exchange rate to two cents higher at 0.7900 has been the main factor behind the Kiwi dollar spiralling above its previous resistance at 0.7300 to new highs of 0.7450. There has been no additional positive economic news in New Zealand recently to propel the NZ dollar higher, it has merely followed the AUD upwards. The NZD tracking the AUD against the USD, however, has not been a smooth and even movement relationship. Initially the Kiwi was slow to respond to the rapid AUD gains to 0.7900, sending the NZD/AUD cross rate sharply lower to 0.9250 on Thursday 20 July. Local AUD exporters who use FX orders to enter new hedging were rewarded with transactions triggered from 0.93500 down to 0.9250. The NZD/AUD cross-rate has subsequently rebounded to above 0.9400 as the AUD progression higher was stopped by the RBA clarification statements.

The appreciation of the NZD/USD rate to 0.7450 has increased the TWI Index to 78.60, substantially above the 76.00 level the RBNZ had assumed through this period for their inflation forecasts. The NZD/USD rate briefly dipped to 0.7260 on 17 July when the CPI inflation result for the June quarter of 0.0% was well below prior forecasts. The lower NZ dollar did not last very long as the AUD surged higher on the ill-considered RBA statement on the same day. The RBNZ now have a tough job themselves to alter financial market perceptions about the timing and speed on NZ interest rate increases. Their next opportunity to condition market expectations and outlook is their Monetary Policy Statement on 10 August. Given the much higher exchange rate level of the TWI above 78.00 (cheaper import prices), the RBNZ are really forced to lower their March 2018 inflation forecast to below 1.00%. Their current inflation forecast is 1.00% by March 2018 based off a 76.00 TWI Index. An official forecast below the minimum 1.00% inflation limit means that they have to signal that the next adjustment to interest rates is lower, not higher. It would seem unlikely that the RBNZ will take such a bold step when other central banks around the world are now starting to signal the ending off their “easy/easy” monetary policies, however if the RBNZ are consistent that is precisely what they should do.

The stronger NZ dollar environment just two months out from a general election certainly does not suggest any worries about political risk for the NZ economy. It is difficult to see that confidence about the non-existent political risk lasting too long. The FX markets have also seemingly forgotten about another potential Kiwi dollar negative in the form of the Trump administration’s soon to be released report on trade protectionism and import tariffs. As has been stated before in this column, any inclusion of agriculture products in any new US border taxes will send the Kiwi dollar sharply lower (as we witnessed in late April when Mr Trump tweeted that dairy products could be added to tariffs on imported Canadian lumber).

The greater risk and probability from current exchange rate levels is a recovery in the USD against all currencies from its recent sell-off, therefore the AUD and NZD both reversing recent gains against the US dollar.