Harbour Navigator - RBNZ takes aim at the currency
29 January 2015 / ContactUs@harbourasset.co.nz / +64 4 460 8300
At today’s Official Cash Rate (OCR) review, the RBNZ shifted their rate outlook from signalling that further rate hikes would eventually be needed, to one that gives no guidance about future direction. In doing so, the RBNZ has been able to take more aggressive aim at the NZ dollar, pushing it around 2% lower.
With inflation potentially falling below zero during 2015, due largely to the fall in petrol prices, the interest rate market was already pricing in some chance the next move would be a cut. The immediate reaction has been to price rate cuts more aggressively, with the probability of a 0.25% cut by December now priced at 80%. The tendency for markets to jump ahead of central banks is not a new one.
The dramatic fall in oil prices has put the spotlight on central banks globally. Most have responded by noting that lower prices act like a tax cut, increasing consumers purchasing power. In other countries, where oil production is a major industry, there are also negative impacts: the Bank of Canada cut rates this month. The challenge for most central banks, however, is to manage inflation expectations in a backdrop of already low inflation. The traditional approach of looking through the near-term impact of oil price moves, can be seen as a little complacent at present. Investors are seeing things this way, with bond yields falling sharply over the last two months.
For the Reserve Bank, the beauty of shifting to a definitively neutral stance is that it diminishes the conflict that existed between the view that the New Zealand Dollar was overvalued and interest rate signals. Future rate hike signals served to underpin the currency and today’s change in language reduces the strength of this. The currency has fallen 2% in the hours after the announcement. Governor Wheeler will be very pleased about this, having repetitively noted the overvaluation of the NZD. Indeed it seems quite likely that the currency was a key target in todays decision.
We will be watching closely to see the reaction from global investors investing in New Zealand. While stress in Europe and Japan have prompted a search for yield and safety, the NZD has been a heavily favoured currency. This is most likely the reason for the overvaluation. While not going to an easing bias, today’s statement and the ensuing fall in the NZD will highlight the risks faced by global investors. At this stage, we feel only a moderate reaction is likely, but if the Reserve Bank was to move to an easing bias, an even sharper fall in the currency could ensue.
Harbour’s research is available on their website, see: www.harbourasset.co.nz
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