Market Musings: AUD/NZD - RBNZ joins the rate cut club
Another one bites the dust with the Reserve Bank of New Zealand today joining the likes of the Bank of Canada, the European Central Bank, and the Bank of England in kick starting its monetary policy easing cycle. The RBNZ delivered a 25bp reduction, lowering the official cash rate to 5.25%. The RBNZ went hard and early during the interest rate hiking phase, and the negative impacts from 15-months of very ‘restrictive’ settings are being felt across the NZ economy. The previously reluctant RBNZ has (finally) seen the light, something we believed was a matter of time (see Market Musings: AUD/NZD - Diverging macro fundamentals). According to the RBNZ with headline inflation within striking distance of returning to its 1-3% target (chart 1), a “variety of core inflation measures moving consistent with low and stable inflation”, services prices cooling inline with “increased spare economic capacity”, and with downside risks to activity and jobs becoming more apparent the Committee “agreed to ease the level of monetary policy restraint”.
Based on the harsher NZ economic climate the start of an extended RBNZ easing cycle is underway. NZ economic activity is projected to be weak over coming quarters with below trend GDP growth anticipated until H2 2025 (chart 2). This is particularly negative when considering the large jump in NZ’s population. On a per capita basis the NZ economy has (so far) contracted for 6 straight quarters. Subpar business and consumer confidence, still elevated mortgage costs, subdued consumer spending and construction, and amplifiers like high debt levels and rising unemployment are still working through the system. Specifically, the labour market is a lagging indicator and the relationship with economic growth points to NZ unemployment getting worse before it gets better (chart 3). The RBNZ is forecasting NZ unemployment (now 4.6%, already 1.4%pts above its COVID-era low) to lift to ~5.4% by early-2025.
According to Governor Orr, and the detail within the updated projections, a “calm” and “data dependent” move back towards ‘neutral’ (which the RBNZ pegs at being a bit under 3%) is in train (chart 4). That said, this is a sea change in the RBNZ’s outlook. Recall, in May the RBNZ had a 'tightening' bias. But because of the improvement in inflation, negative underlying conditions, and shift in the balance of risks the RBNZ has taken an axe to its interest rate forecasts. The RBNZ is implying ~165bps worth of cuts between mid-2024 and end-2025, up from only ~40bps of easing predicted in May (chart 5).
All up, today’s RBNZ pivot and turn in the NZ monetary policy cycle reinforces our ‘bearish’ bias towards the NZD. A swift turnaround from the RBNZ could be a multi-faceted pressure point for the NZD. A closer look finds NZ’s wide current account deficit position (now an above average ~6.8% of GDP) has been increasingly funded by foreign investors drawn in by attractive yields (chart 6). A reduction in NZ’s interest rate advantage as the RBNZ eases policy to support growth may expose the NZD to downside risks because of the possible drying up of capital inflows needed to fund the external imbalance.
In terms of AUD/NZD the diverging economic and policy impulses between Australia and NZ are becoming clearer (chart 7). In contrast to the RBNZ’s dovish tilt, the RBA remains concerned Australian inflation pressures still haven’t been extinguished and continues to talk tough about the possibility of another rate rise (see Market Wire: RBA: Hold your horses). While we don’t believe the RBA will hike interest rates further we remain of the view that the RBA should lag global counterparts such as the RBNZ in terms of when it starts and how far it goes during the next easing cycle. Relative fundamentals such as yield differentials look set to move progressively in the AUD's favour and a higher AUD/NZD. In our opinion, AUD/NZD, which has jumped back over 1.10 in the wake of today’s RBNZ announcement, has further room to run. Our long-held forecast has been for AUD/NZD to edge up towards ~1.13 by Q4. This may arguably be on the low and slow side based on signals coming through from our models (chart 8).
Peter Dragicevich
Currency Strategist - APAC
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