Opinion: Markets still split on 50 or 75 bps cut in OCR this morning

By Danica Hampton There should be plenty to occupy market participants today. The RBNZ makes its monetary policy decision this morning and the Australian employment report is due this afternoon. Market participants expect the RBNZ to cut interest rates, but are spilt on whether the central bank will cut 50bps or 75bps. Our economists are officially looking for a 50bps cut, but wouldn't rule out a 75bps move. More important than the size of today's rate cut, we remain convinced the RBNZ will continue cutting rates until the OCR reaches 2.00% by mid year. Current market pricing is consistent with the OCR troughing somewhere between 2.25-2.50% "“ so there is some scope for NZ interest rates to fall if today's RBNZ statement is consistent with our view. Even if the RBNZ cuts just 50bps to 3.00%, this will see the NZ cash rate fall below the Australian cash rate for the first time since 2004. In currency markets, much attention has been given to the fact that the NZ cash rate will likely fall below Australia's today and this has encouraged a bit of NZD/AUD supply over the past few weeks. However, we'd point out this negative interest rate differential is unlikely to persist "“ our forecasts have both the RBNZ and RBA cash rates troughing at 2.00% later this year. As such, we're not convinced that dips below 0.7700 in NZD/AUD will be sustained. More clues on the outlook for the Australian economy will come from the employment report (due 1:30pm NZ time). The market expects employment fell by 20,000 jobs in February and looks for the unemployment rate to rise to 5.0%. In light of the RBNZ decision today, the downside remains the greater risk for NZD/USD today. However, it's difficult to get too excited about the currency while it's trading within familiar ranges. On the downside, solid support is expected around the 0.4900-0.4920 region (and a break below last week's 0.4895 low is needed to suggest the downtrend is gaining traction). On the topside, initial headwinds are expected around 0.5075-0.5080. The USD slipped a little lower against most currencies last night. But there wasn't a clear direction in currency markets as investors were forced to digest a mix of weak global data, flat equities and official speak ahead of the G20 meeting. EUR/USD rose from below 1.2650 to above 1.2800, while USD/JPY slipped from above 98.50 to below 97.50. The economic data released yesterday did little to inspire confidence in the outlook for global economic growth. China's trade data for February was much weaker than expected. Exports dropped 25.7%y/y (vs. -1.0% forecast), while imports shrank 24.1%y/y (vs. 22.5% forecast). The net result saw the trade balance fall to a 4-year low of US$4.84b. Japan's machine orders fell just 3.2%m/m in January (slightly better than -4.8% forecast), but the annual drop of 39.5%y/y is the largest on record. In Europe the economic news wasn't any better. The UK goods and services deficit widened slightly to £3.6b in January from a revised £3.2b in December. German manufacturing orders fell by 8.0% in January (vs. -2.0% forecast), which suggests downside risks to tonight's industrial production data. Despite the worsening economic news and yesterday's strong surge, global equities were more or less flat. The FTSE fell 0.6%, but the DAX rose 0.7% and the S&P500 is currently up 0.1%. Ahead of this weekend G20 meeting, the debate about whether governments have done enough to fight the financial crisis is intensifying. Overnight US Treasury Secretary Geithner has called for leaders to "substantially" increase the funding for the IMF in order to help emerging market and developing economies. Geithner's comments reaffirm the view that we'll need to see the global economy stabilise before industrialised economies like the US can sustain a recovery. The IMF has called for G20 countries to increase their fiscal spending to around 2% of GDP in 2009 and 2010 (a benchmark that only the US, China, Saudia Arabia and Australia are currently on track to meet). In comparison to the "no-holds-barred" approach taken by the US, UK and Japan, the European policymakers have been much more measured. We suspect the European policymakers will be under pressure to justify their policy response at this weekends meeting. Furthermore, with Eurozone GDP likely to contract nearly 4% this year (the sharpest decline in the G7) we think further ECB cuts, fiscal packages and quantitative easing will be necessary. * Danica Hampton is BNZ's Currency Strategist. All of the research produced by the BNZ Markets team of economists is available here.