The extended elevated run by the NZD is undermining RBNZ inflation assumptions, may induce an OCR hike interruption

by Raiko Shareef

NZ Dollar

The NZD is 0.3% weaker against the USD this morning, sitting at 0.8630.

Yesterday, the main event was the Q1 2014 CPI reading, which revealed an inflation rate of 1.5% y/y, lower than the market and the RBNZ, which were both expecting 1.7%.

The miss was entirely driven by tradeable inflation – clearly the high NZD had a stronger impact on prices than the RBNZ expected.

The implications are twofold: (1) the RBNZ has a lower starting point for inflation, and (2) they will be more wary about how an even stronger NZD will affect their inflation track going forward.

The NZ TWI remains above 80.0, still 1.7% above the RBNZ’s forecast for Q2 2014. Should this remain elevated over the quarter (not our central forecast), the OCR track indicated in March might be lowered or at least interrupted with some more pauses.

By mid-afternoon, the NZD/USD was 0.75% lower at 0.8580, but has since retraced most of that move.

Nevertheless, the combination of continued weakness in milk prices (evidenced by the dairy auction early yesterday morning) and softer inflation has dented the appeal of the NZD.

Amongst the crosses, the NZD/GBP was belted by a stellar UK employment report. The cross is 0.6% lower at 0.5140. We see this as part of an ongoing correction toward the 0.50 mark, which is our end of year target.

Today sees ANZ job advertisement and consumer confidence readings in NZ. These will attract only passing attention. The job ads series can afford a modest negative and still keep a strong positive trend, while consumer confidence will likely be negatively impacted by the first RBNZ rate hike in March.

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Majors

Risk sentiment improved overnight, thanks to positive surprises in economic data in various parts of the world, as well as positive earnings results out of the US.

In our time zone yesterday, China announced Q1 2014 GDP growth of 7.4% y/y, down from 7.7% the previous quarter, but marginally stronger than the slide to 7.3% expected by the market. The set of monthly indicators released at the same time were broadly positive, with retail sales and industrial production accelerating in March.

The market reaction was fairly muted, but it is likely no coincidence that the AUD was one of the strongest G10 performers against the USD overnight, up 0.2% to 0.9380.

Later in the session, a stand-out UK labour report put the GBP atop the G10 FX leader board. The unemployment fell declined from 7.2% to 6.9%, trouncing expectations of a much more modest decline to 73.1%.

The sheer strength of employment growth was the driver here, with the unemployment rate falling despite an increase in labour force participation. The GBP leaped higher on the data, and justifiably so. The GBP/USD is 0.4% higher at 1.3820.

In the United States, industrial production for March rose by 0.7% m/m, a modest positive surprise against the 0.5% consensus expectation. But the real surprise was in the revision to February’s read, which doubled from 0.6% to 1.2%. The good news story here outweighed the slightly disappointing housing market data, which still maintain a broadly positive trend.

Fed Chair Yellen’s speech last night would have had some investors on edge, given her recent track record of mixed messages and resultant market volatility. They need not have worried. Ms Yellen retained the softer tone of her most recent remarks, emphasising the shortfall between the Fed’s objectives and the current economic situation. For one thing, the unemployment rate of 6.7% is well above the Fed’s latest estimate of ‘full employment’, which is somewhere between 5.2% and 5.6%.

After yesterday’s packed data calendar, today offers a welcome respite ahead of the Easter holiday. The only releases of note are out of the US. Initial jobless claims and the Philly Fed index will be watched, but are not top-tier outturns in themselves.

All its research is available here.