New Zealand Dollar to Fall as Risk Trends Overwhelm Rate Hike

While the RBNZ is all but certain to begin removing monetary stimulus at the policy meeting on June 9, the announcement’s implications may prove limited considering the outcome has had ample opportunity to be priced into exchange rates. Indeed, a Credit Suisse gauge of the priced-in policy forecast reflects that traders have seen a 70 percent or greater chance of a 25bps increase in benchmark borrowing costs for all of the past week.

Any boost to the currency following the release may be further muted by a tame statement on future rate hikes from RBNZ Governor Alan Bollard, who has stated in no uncertain terms that “a gradual depreciation of the New Zealand Dollar remains desirable” and will surely be mindful of the impact that a hawkish posture would have on the exchange rate. The central bank chief has ample ammunition to justify a cautious approach to tightening monetary conditions: the annual inflation rate stands at a comfortable 2 percent, the Chinese economy – a major driver of the rebound in exports – is set to slow as policymakers in Beijing proactively restrict growth amid fears of asset bubbles and runaway inflation, and the government’s latest budget includes plans to raise sales taxes to trim consumption and encourage saving. Further still, the fiscal deficit is expected to rise to 27 percent of GDP over the next five years from 14 percent in 2010, which promises to push up financing costs. All this is set to bear down on economic growth and contain inflationary pressure, thereby reducing the need to aggressively pursue higher interest rates.

Looking past the rate decision, a return to risk aversion may prove to be the dominant force driving price action. Currency markets went into last week on a mission to size up the ability of the United States to support the global economic recovery, with May’s NFP report serving as the benchmark gauge. Indeed, with EU growth buried under a growing pile of debt and China proactively slowing its buoyant economy amid fears of asset bubbles and runaway inflation, the US was left as the last major engine of growth where some hope could be had. As it stands, the jobs report proved disappointing, opening the door for renewed selling of risk-linked currencies including the New Zealand unit.