The dollar rises sharply as inflation expectations increase, lessening the likelihood of an OCR cut next month

There was a sharp jump in the value of the New Zealand dollar following the release of the Reserve Bank's Survey of Inflation Expectations, which came in higher than expected.

The NZD jumped from 73.6 USc to 74.30 USc and from 92.33 AUc to 92.85 AUc following the release of the survey results, which showed that inflation is expected to be running at 1.85% in two years' time, up from 1.8% in the March survey. The one-year ahead view of annual CPI inflation has risen to 1.32%, from 1.11%.

That is likely to have caused financial market players to have concluded that the Reserve Bank is less likely to cut the OCR in the near future, increasing the chances it will keep the OCR on hold for longer.

"This is an important development for RBNZ watchers," Westpac chief economist Dominick Stephens said in a note after the survey results were released.

"The RBNZ has stated that it will keep the OCR on hold unless wage and price setting behaviour settles below the 2% target and the domestic economy cools, in which case it could reduce the OCR.

"Financial markets have begun leaning heavily towards OCR cuts actually occurring, on the basis that new regulations will cool the housing market and inflation expectations will drop away.

"Most economists, ourselves included, would have expected the Inflation Expectations Survey to drop away to around 1.6%, given that actual inflation has fallen so far."

Stephens said four key surveys of inflation expectations had broadly stabilised, and that called into question the idea that price setting behaviour would settle below the RBNZ's 2% target.

"On balance, arguments for OCR cuts based on the state of inflation expectation have been weakened,"  he said.

"We remain firmly of the view that a June OCR cut is unlikely. Whether the RBNZ cuts later in the year or not is a closer call, but at this stage our forecast is for no cut."

In her note on the survey results, ASB senior economist Jane Turner said they made an OCR cut less likely in June and that had lifted the New Zealand dollar, but she still expected rate cuts later in the year.

"Our two year ahead forecast for inflation is currently just 1.7% and given the subdued inflation outlook we continue to expect rate cuts from the RBNZ," she said.

"We expect two, 25 basis point cuts, in September and October respectively," she said.

Meanwhile, BNZ senior economist Craig Ebert said; "Have to say, we never thought we’d live to see the day when a decimal point change on the RBNZ inflation expectations variables would move NZD at least half a cent. But that’s what’s occurred. Tells you a lot about the market. They want to see the negative."

"We don’t see a compelling case for OCR reduction in the immediate term. However, a case for it might develop as the year progresses. We prefer to wait and see and we think the RBNZ will see the sense in this approach as well," Ebert added.

The RBNZ next reviews the OCR, currently at 3.50%, on June 11.