New Zealand Dollar May Fall Ahead of RBNZ Rate Decision

Interest rate traders price in a negligible 5 percent chance that the RBNZ will raise rates at their upcoming meeting, but markets will nonetheless watch for substantive changes in rhetoric from the NZ central bank. RBNZ Governor Alan Bollard had previously estimated that the bank would begin raising interest rates through late 2010, but he recently suggested that monetary policy tightening could come as soon as mid-year. The modest disappointment in Q4 CPI data forced a pullback in rate hike expectations and Overnight Index Swaps pulled back accordingly. Yet it serves to note that the year-over-year inflation number stands exactly at the bottom of the RBNZ’s target range of 2-3 percent. Given that this is an inflation reading during times of subdued economic activity, one suspects that the RBNZ is concerned of a noteworthy pickup as the economy exits recession. Traders should pay especially close attention to any references to the timing of rate increases. The yield-sensitive New Zealand Dollar will likely respond sharply to any suggestion that rates will be hiked sooner or later than market forecasts.

It otherwise remains critical to monitor the US S&P 500 and broader financial market risk sentiment. Given a US Federal Open Market Committee interest rate announcement due this week, US financial markets may prove especially volatile on any surprises from the domestic central bank. The past week’s sharp pullbacks certainly warn that this may be the start of a larger correction, and indeed it seems that NZD risks remain to the downside through recent signs of financial market turmoil.  - DR