By Danica Hampton

The NZD was the strongest performing currency last week. NZD/USD climbed from below 0.7000 to above 0.7150 and the TWI rose about 1.6%.

Solid demand from both macro and leveraged accounts, combined with further recovery in NZD/AUD, helped support the NZD/USD last week. It seems markets have come around to our view that a NZD/AUD below 0.7700 is unjustified on the basis on NZ’s economic fundamentals. We are picking annual average GDP growth for NZ of 3.1% for calendar 2010 and 3.5% for 2011. While hardly awe inspiring, such an outcome would see Australia’s growth advantage largely eroded by year-end. If AU-NZ growth differentials narrow as we expect, NZD/AUD should continue to trend higher in coming months, albeit slowly.

Despite performing strongly for much of last week, the NZD hit a stumbling block on Friday night. In a surprise move, the Bank of India (BoI) raised its repo rate to 5.00% from 4.75% and said controlling inflation was “imperative”. The tightening from the BoI raised fears that central banks from other emerging economies may soon follow suit and sparked fears about how the global economy would cope. The BoI decision took a toll on commodity prices, equities and risk appetite. The CRB Index fell about 1% on Friday night and the S&P500 fell 0.51%.

Worries about the global outlook saw investors ditch growth sensitive currencies like the NZD in favour of the relative safety of the USD. NZD/USD breached 0.7100 and skidded below 0.7070. However, rumoured sovereign demand for risk currencies as well as fix related buyers helped lift NZD off its lows as the week drew to a close.

The global outlook isn’t looking too promising this week. The hangover from Friday’s BoI decision will likely temper risk appetite and demand for growth sensitive currencies like NZD early this week. However, the main event will likely be the EU Summit (March 26 & 27), where investors will be looking for a steer on what, if any, agreement the EU come to in terms of a bailout package for Greece.

Meantime, there’s also a lot of NZ data to keep an eye on. Wednesday should confirm the current account deficit is rapidly shrinking, it’s expected to improve from Q3’s -3.1% of GDP to -2.1% in Q4. And we’re looking for a relatively solid 0.8%q/q expansion in Thursday’s Q4 GDP release.

The global backdrop of tempered risk appetite, and a weaker EUR, may weigh on NZD/USD early in the week. With the NZ data expected to confirm a relatively solid NZ economic picture, we suspect any dips below 0.7000 will be relatively short-lived this week.

Risk aversion saw the USD strengthen against most of the major currencies on Friday night. Risk appetite was zapped by modest losses in global equities and an unexpected tightening in Indian interest rates.

The Bank of India (BoI) increased the benchmark reverse repo rate to 3.50% from 3.25% and the repo rate to 5.00% from 4.75%. In an accompanying statement, the BoI said controlling price gains became “imperative” after inflation accelerated to a 16-month high. The decision surprised markets as it came a month before the bank’s scheduled monetary policy meeting.

India’s interest rate rise sparked worries that other Asian central banks may soon follow suit and raised concern that the removal of economic stimulus will hinder global growth. As a result, both commodity and equity prices suffered. The CRB Index, a broad measure of commodity prices, fell about 1% on Friday night. Gold prices fell 1.9% to US$1,107/oz. The S&P500 finished the night down 0.51% and the Dow Jones fell 0.35% - its first drop in nine days.

Fears about the global outlook sent growth sensitive currencies like the NZD, AUD and CAD lower. However, problems in Europe added to the weight on EUR and GBP. GBP/USD tumbled from above 1.5150 to around 1.5000 after the Bank of England’s Sentence said “there is some risk of a UK double-dip recession”.

The EUR recorded its biggest weekly drop since January, falling from above 1.3800 to nearly 1.3500. The confusion as to whether or not the EU will support Greece continues – Germany’s Merkel told parliament last week that the IMF may be the only solution to Greece’s woes. However, ECB President Trichet and French PM Sarkozy have expressed concern that an IMF bailout would suggest the EU can’t solve its own crises. Either way, the failure of Greece to secure financial assistance from the European Union continues to rattle EUR sentiment.

While there’s a handful of Fed speakers scheduled this week, there is little in the way of key US data. In the UK, the CPI and the UK Budget will garner attention. However, the EU Summit (March 25 & 26) will likely be the key event, with market participants watching to see what agreement is made in terms of a rescue package for Greece.

Ahead of the EU Summit, concerns about Greece’s funding difficulties are expected to limit bounces in EUR/USD to around the 1.3700 region. Meantime, the USD will likely remain firm as investors fret about how the global economy will cope with further stimulus removal.

*All of the research produced by the BNZ Capital team of economists is available here