Draghi fails to convince markets that the ECB policy settings are correct. No change by the RBNZ next week may see the NZD rise

By Raiko Shareef

The EUR is sharply higher once more, as European bonds continue to sell-off.

Other major currencies are flat or weaker against the USD, with NZD holding the wooden spoon.

NZD/AUD has settled tentatively below 0.92.

EUR’s outperformance can be squarely laid at the feet of another massive jump in European bond yields. However, investors first had to face the prospect of the ECB’s policy decision, with attendant press conference by ECB President Draghi. While the overall tone of the ECB’s policy message was more cautious than in April, Draghi clearly failed to convince the market that the ECB might, at some point, be forced to pare its QE program ahead of time.

In its policy statement, the ECB actually downgraded its assessment of the euro-zone economy, removing the April version’s references to an economy strengthening and gaining momentum. On the other hand, the ECB upgraded its 2015 inflation forecast from 0.0% y/y to 0.3%. Draghi did note that the ECB is not satisfied with the recent rebound in inflation, and will need to observe medium-term trends. For investors, this leaves the door ajar for an adjustment in policy, if European inflation continues to recover strongly. EUR/USD rallied to just shy of 1.13.

The AUD failed to hold its head above 0.78 overnight, having broken to those heights after yesterday’s strong Q1 GDP report. The better-than-expected print was led by a very strong housing component, while investment remains very weak. Overall, our NAB colleagues believe this will encourage the RBA that the non-mining economy is responding positively to prior rate cuts. We expect the current 2.00% policy rate will mark the bottom in this cycle.

NZD/USD sits at the bottom of the leader-board, continuing to underperform its peers. There has been little fresh news to justify its poor performance. Some may point to the RBNZ’s consultation paper on property investor controls, released yesterday. In it, the Bank noted it saw the rising risk of a substantial correction in the Auckland housing market, and that its new measure will reduce house prices by 2-4%.

The offshore hedge fund community, which has long been looking for a June rate cut, may have taken this paper as an encouragement ahead of next week’s meeting. We would not regard it as fresh information. We continue to see the RBNZ keeping the OCR steady next week, a result likely to elicit a jump in NZD. The magnitude of that jump will depend entirely on the Bank’s forward guidance.

Yesterday’s Australian GDP report saw the NZD/AUD cross sink below 0.92, and it has settled just below that level. There looks to be good support at 0.9170, thanks to the big 1.09 level in AUD/NZD. We’d expect NZD/AUD to return to our end-June target of 0.95, if the RBNZ stands pat next week.

Today’s data calendar is light, and the market will more likely be led by the direction of EUR, which in turn will follow German bond yields.

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Raiko Shareef is on the BNZ Research team. All its research is available here.