The New Zealand dollar index fell sharply this morning after the country’s central bank left the official cash rate (CR) on hold at 1.75%.
At midday, the NZD index was down 1.6%. Against G10 currencies, the heaviest falls are against the Japanese yen (1.7%) and the Aussie dollar (-1.3%).
Analysts were in agreement that it was the Reserve Bank of New Zealand’s (RBNZ) dovish statement following the announcement that drove this morning’s move lower.
Markets were surprised by the RBNZ’s softer predictions for future growth after stronger than expected inflation figures in Q1 2017.
“With inflation having been quite a bit higher than forecast in 1Q, mostly due to tradables, there was a chance the RBNZ would get twitchy, possibly worrying that the decline in NZD was taking the inflation trajectory out of its control,” JP Morgan economist Ben Jarman said.
In fact, the central bank reduced its inflation forecast for 2018 on the basis that the surprise increase in March was due to temporary factors.
ANZ economists Cameron Bagrie and Philip Brooks said that “the RBNZ’s inflation profile in 2018 in particular looks remarkably benign (especially with growth forecast to remain above trend), with headline inflation falling back to 1.1%”.
Not only that, but the RBNZ also said that its neutral stance on monetary policy is now expected to be maintained to the third quarter of 2019. That was well beyond market forecasts, according to Westpac’s Sean Callow.
“There had been widespread talk that this could be brought forward to March 2019, given the upside surprise on inflation, higher dairy prices and slide in unemployment rate,” Callow said.
This chart from JP Morgan shows the RBNZ’s latest forecast for the official cash rate:
The more dovish tone from the RBNZ suggests that it was wary of the New Zealand dollar getting too high.
According ANZ’s Bagrie and Brooks, “the RBNZ appears to be more comfortable regarding the NZD, which it notes has fallen, and if sustained, will help re-balance the growth outlook”.
“Further depreciation is no longer explicitly noted as being needed,” they said.
Westpac’s Callow notes that the the New Zealand dollar was the best performing currency in the G10 in May, “with fundamentals seemingly supporting a more upbeat statement from the RBNZ today”.
Jarman sighted structural indicators of higher funding costs for banks as a key theme that would keep interest rates low. He said that New Zealand banks were nearing their wholesale funding capacity which would which increase competition for deposits.
“We are expecting the RBNZ to remain on hold through 2017-18,” Jarman said.