FxWirePro: Glimpse over why looming RBNZ cut seems most likely after China flashes, Kiwi dollar to confront bearish pressure again

The RBNZ made it clear last month that it will be returning to the easing table, and like the consensus, we expect a 25bp OCR cut to 2.0% this week – an all-time low. This is fully priced by the market.

As a result of this speculation in the FX market, the New Zealand dollar moved lower sensing more bearish pressures in the weeks to come especially after data showed that China’s imports dropped far more than expected last month and as the greenback remained supported by Friday’s strong U.S. jobs data.

You may probably know that the China has been the biggest contributor of Aussie and Kiwis trade balance. Earlier Monday, data showed that China’s imports declined by 12.5% in July, compared to expectations for a 7.0% drop. Exports fell by 4.4% last month, compared to expectations for a 3.0% fall.

In fact, the market looks to be placing some odds on a 50 bps cut. We struggle to see the rationale for a larger move when the economy is performing well. Historically, the RBNZ has delivered larger cuts only in “emergency” situations – hardly the case at present. But we expect an explicit easing bias to be retained, with the bill projection implying at least one more cut, and alternative scenarios reinforcing more if required.

The reality remains that the strong NZD is making it “difficult for the Bank to meet its inflation objective”.

The strong NZD will lower the Bank’s near-term annual inflation forecasts by perhaps around 0.5%pts, mechanically forcing a lower 90-day bank bill profile. We expect it to signal at least one further OCR cut.

With the NZD increasingly battling a portfolio shock (and being supported by strong domestic activity growth) the OCR needs to go a lot lower to take the NZD down with it. 

Inflation is low for reasons beyond the RBNZ’s control and we see little problem with sustained low inflation for a period, as opposed to the RBNZ ‘needing’ to hit the 2% target. A deflationary rut is not around the corner. Some pragmatism over the Policy Targets Agreement is required.

In the meantime, one thing that looks set to help the RBNZ with some of the tensions it faces (NZD vs housing) is a rising wedge between wholesale and retail borrowing rates. We are not expecting the full OCR cut to be passed on to borrowers.

In fact, in Australia following the latest RBA cut we saw some deposit rates actually rise! Similar funding pressures are evident here.

That should give the RBNZ some comfort that a lower OCR can be directed more towards the NZD and inflation with less consequential flow-on into sectors such as housing that don’t need more of a boost (and arguably need less).