Will RBNZ Pour Cold Water on Rate Cut Expectations?

• Since the last RBNZ meeting, data have been coming on the weak side
• Investors see no more hikes and expect 40bps worth of cuts for 2024
• But the RBNZ is unlikely to satisfy market bets
• The meeting is scheduled for Wednesday, at 01:00 GMT

Data points to softening economic activity

At its latest gathering, the Reserve Bank of New Zealand (RBNZ) held its Official Cash Rate (OCR) steady at 5.5%, noting that interest rates are constraining economic activity and are reducing inflationary pressures as required. Officials also added that there is a near-term risk that activity and inflation do not slow as much as needed, and that’s why the policy rates should stay at restrictive levels for a sustained period of time.

Since then, data have been pointing to further softening of economic activity, with retail sales shrinking 0.8% q/q in Q3 after dropping 1.0% in Q2, and the business PMI for October sliding to 42.5 from 45.3. What’s more, the unemployment rate increased further to 3.9% from 3.6% during Q3 and the CPI slowed to 5.6% y/y from 6.0%. All these numbers allowed investors to continue believing that this tightening crusade is over and to pencil in around 40bps worth of rate cuts for next year.

But upside risks to inflation unlikely to result in a dovish RBNZ

The Bank’s upcoming gathering is scheduled for Wednesday, with analysts agreeing with the market that officials are most likely to keep their hands off the hike button. Therefore, the attention is likely to fall on the Bank’s new macroeconomic projections and any clues on how they are planning to proceed with monetary policy in 2024.

Given that inflation is still nearly double the upper bound of the RBNZ’s 1-3% target range, and that, although cooling, the RBNZ’s own expectations continue to suggest that inflation will stay above that bound in 12 months, officials are unlikely to affirm market expectations and revise lower their OCR projections.

What’s more, it will be interesting to see whether policymakers will incorporate into their forecasts the implications of a new government for the macroeconomic outlook. An official agreement has yet to be signed, but the new coalition is more likely to be led by the National Party, which promised less spending than the previous Labor-led government, but also tax cuts, which is an inflationary policy. It also called for a change in how the RBNZ conducts policy, arguing that the dual mandate should be dropped and suggesting the adoption of a stricter inflation targeting. This means that if the Bank switches to a 2% objective like other major central banks, policy may need to stay restrictive for longer than previously estimated to achieve that target. According to the RBNZ’s inflation projections, inflation would not be at 2% even in 2 years.

Kiwi may have room to gain more

Having all these variables in mind, even if officials lower their short-term inflation projections based on the latest data releases, the longer-term outlook is unlikely to be changed much, and they will most likely continue to suggest that interest rates will finish 2024 at the current 5.5% level. Compared to the market’s own implied path, this could be interpreted as a relatively hawkish hold and could prove positive for the New Zealand dollar, which has been outperforming its US counterpart lately on speculation that the Fed may need to cut interest rates by around 90bps next year.

Apart from monetary policy, the kiwi is also driven by the broader risk-appetite and developments surrounding the Chinese economy, New Zealand’s main trading partner. The market expectations regarding the Fed’s future course of action have triggered a wave of market euphoria, fueling the latest rally in stocks, and that’s why the risk-linked kiwi and aussie gained more than other currencies against the dollar. On top of that, despite the major problems facing the Chinese economy, the latest data releases are suggesting that the world’s second largest economy may be bottoming out, which is another plus for the kiwi and its neighboring aussie.

From a technical standpoint, kiwi/dollar has been printing higher lows and higher highs since the October 26 bottom, while today, it poked its nose above the crossroads of the 200-day exponential moving average (EMA) and the 0.6060 key zone. If the week closes above that hurdle, then the bulls may decide to climb towards the 0.6130 barrier, marked by the high of August 4, the break of which could carry larger bullish implications.

For the outlook to darken again, kiwi/dollar may need to slide and close below the 0.5940 barrier, a move that could pave the way towards the next support zone, at around 0.5860.