BNY Mellon

RBNZ Might Run Out of Room

The Reserve Bank of New Zealand is expected to hike its policy rate by another 50bp this week, but the market has long since given up on using the NZD as one of the proxies for advanced policy expectations generating currency performance. Be it liquidity preference or concerns over domestic performance, throughout the year we have noted with immense frustration that the market repeatedly failed to acknowledge the RBNZ’s revisions higher to its terminal rate. Even on a relative basis, such as vs. AUD, the NZD has consistently underperformed. This has been despite retaining general rate advantages, and arguably retaining a lower beta to global risk conditions, such as China’s growth woes and energy matters. NZD OIS still suggest that a 5% terminal is possible, but we think the RBNZ would struggle to match that. Even if it did, we doubt NZD would find much traction beyond a short-term bounce considering where pricing for the Federal Reserve stands.

Much of the inflation impulse within New Zealand and associated supply issues were self-driven through fiscal and monetary support. The withdrawal process should mostly be reflected in domestic weakness as well, rather than imported pass-through. This means that as a policy objective, the RBNZ is unlikely to push for currency strength in the same way that other small, open economies, such as Switzerland and Sweden, have done. Even select policymakers in the Eurozone and UK have pushed for a stronger currency on an outright basis, but this has not had the anticipated policy impact because the Fed is so far ahead.

The RBNZ should also have a broad idea on the distribution of the Q3 inflation print. While we expect ongoing strength in tradables, risks to the non-tradables seem clearly skewed to the downside. Although the level of declines is small, the RBNZ cannot escape the fact that domestic-based non-tradable inflation has fallen for three straight quarters; a fourth is likely. The RBNZ’s previous forays into FX intervention weren't the most favourable, so we expect the RBNZ to let the NZD run its course and focus its efforts on domestic demand.

The trajectory of non-tradables inflation suggests that large upward revisions to the policy path and terminal rates at the Monetary Policy Statement (MPS) to follow in November are unlikely. However, we cannot rule out the RBNZ changing its view on tradables inflation and subsequently looking to pursue a more aggressive NZD view through rate hikes beyond the August MPS projections. The current outlook is for tradables inflation to fall to 5% by year-end and, crucially, import prices are expected to fall by 3% in 2023 and a further 1% in 2024 in NZD terms. For now, the distribution of inflation remains broadly in line with the RBNZ’s expectations. If there is no material downside drag in the rate path out to 2025 (4.0% average), NZD losses should be limited considering current positioning and valuations.