Market Musings: AUD/NZD: RBNZ delivers
The RBNZ has followed through and crystalized the built-up market expectations by delivering a 50bp interest rate cut at today’s monetary policy review. The move, the second interest rate reduction this cycle, lowers the RBNZ’s Official Cash Rate from 5.25% to 4.75%. The OCR had reached a peak of 5.5% during the RBNZ hiking phase which had put policy settings well into ‘restrictive’ territory.
The economic winds of change are blowing hard in NZ. According to the RBNZ inflation is back in the 1-3%pa target band, activity is subdued with business investment and consumption weak, employment conditions have continued to soften, and the NZ economy has ‘excess capacity’. This is broadly inline with our assessment of the state of play with the RBNZ’s previous aggressive tightening still working its way through the system and a key factor behind the harsher NZ economic climate. Indeed, as we discussed, timelier measures of employment indicate job losses are mounting while price pressures are clearly waning (see Market Musings: AUD/NZD: RBNZ needs to get moving). NZ’s inflation dragon has been slayed, allowing the RBNZ to turn course in an effort to revive growth and limit the labour market damage.
With this in mind, and assuming the RBNZ’s ‘least regrets framework’ continues to hold, we expect interest rates to be lowered down towards ‘neutral’ (i.e. ~2.75-3%) or slightly into ‘accommodative’ territory more quickly than the RBNZ had been anticipating only a few months ago. The minutes of today’s RBNZ meeting noted that “changes to the OCR would depend on its evolving assessment of the economy”. Based on current macro trends and with the RBNZ’s policy stance still too tight, dropping the level of interest rates via outsized 50bp clips over future meetings looks more likely than not, in our opinion. The RBNZ next meets on 27 November before it gets together again on 19 February 2025.
From our perspective, a steady stream of RBNZ interest rate cuts and the reduction in NZ’s interest rate advantage should create lingering headwinds for the NZD. That said, with the US Federal Reserve also set to deliver additional interest rate relief, and authorities in China starting to inject more stimulus to boost growth, there are several push-pull forces at work. On net, we see NZD/USD hovering around ~$0.61-$0.62 over the coming quarters. However, given FX is a relative price, we believe the clearer contrasting fortunes between Australia and NZ, and diverging RBA and RBNZ policy impulses with interest rates looking set to step down quite quickly in the latter, points to a further reversal higher in AUD/NZD (move down in NZD/AUD). As shown, our models are indicating AUD/NZD may be too low (NZD/AUD is too high) based on a broad set of underlying drivers. Assuming the RBA keeps rates steady until early 2025 before embarking on a modest easing cycle, we see AUD/NZD edging up towards ~1.15 by Q1 2025 (NZD/AUD down towards ~0.87).
Peter Dragicevich
Currency Strategist - APAC