Opinion: Round of big OCR cuts to weigh on NZ dollar

By BNZ Currency Strategist Danica Hampton NZD/USD slipped from nearly 0.5550 to below 0.5440 on Friday night pressured by rumours of huge month-end fix demand for USD and a sharp slide in EUR/USD (after data revealed drop in Eurozone inflation pressures and rising European unemployment). However, a rebound in US equities into the close (the S&P500 finished up nearly 1%) combined with some macro account demand for NZD saw NZD/USD finish the week around 0.5500. The local news continues to drag on NZD/USD. There is no doubt that the RBNZ will cut rates aggressively on Thursday: we believe 150bp is now likely, and certainly nothing less than three figures is being contemplated. Above all, it's the inflationary outlook that drives the RBNZ's monetary policy decision making and by most measures inflationary pressures are dissipating rapidly (thanks to a massive drop in global commodity prices and the prolonged contraction in domestic activity). In addition, the global slow-down continues to add downside risks to the NZ economy and the NZD. Last week's Agrifax report showed that dairy prices have taken another dive. Our weighted average USD measure fell 8% for the week and is down about 48% from the peak seen last year. Continued falls in global dairy prices increase the risk of further downgrades to Fonterra's payout expectations for the 2008/09 season. Globally, the big question is whether this week's bevy of aggressive rate cuts (RBA, RBNZ, BoE and ECB) sees equities bounce and the USD slide? Or whether the outsized rate cuts are seen as a warning of how bad things are and push the USD higher? We suspect the combination of negative US data will see the latter win out and this should help limit the topside in NZD/USD. For today, we suspect NZD/USD will find headwinds on bounces towards 0.5540-0.5550 and initial support is seen ahead of 0.5450. A break below this level will open up the downside towards 0.5390-0.5400. The USD strengthened against most of the major currencies on Friday night, underpinned by weak European data and rumours of month-end fixing demand. Global stock markets edged higher on Friday night. The S&P500 finished the night up 0.96% and 12% higher than a week ago. Strong gains in financial stocks and economic bellwethers like General Electric helped overshadow weakness in retailers' shares as investors hope fiscal stimulus combined with this week's anticipated rate cuts will help shore up confidence in the global economy. Despite the rebound in global equities, EUR/USD slipped steadily from above 1.2950 to below 1.2650 pressured by month-end demand for USD and soft European data. Not only did Eurozone CPI drop markedly (from 3.6%y/y to 2.8% in November), but the unemployment rate climbed from 7.5% to 7.7%. Everyone agrees the ECB will cut rates this week. The debate is over how large the rate cuts will be. The consensus looks for a 50bps cut to 2.75%. However, data continues to deteriorate at an increasingly rapid pace and the recent easing of inflation pressures means there is scope for a bolder 75bps cut. Last week the ECB's Weber said there was "ample room" for the ECB to move on interest rates and noted that the central bank will take advantage of this room. Aggressive rate cuts are expected by other central banks this week. The Bank of England is expected to cut 100bps, the RBNZ will likely cut at least 100bps and the RBA is expected to cut 75bps. The question this week is whether the bevy of large rate cuts (RBA, RBNZ, BoE and ECB) adds to confidence and sees equities bounce and the USD slide? Or whether investors view the outsized rate cuts as just another warning of how bad things are and push the USD higher? Friday night's heavy demand for USD (reportedly tied to month-end currency hedge rebalancing) gives the USD a head start. We suspect the combination of some very negative tier one US economic releases (manufacturing and services ISM and non-farm payrolls), the round of aggressive rate cuts and anecdotal evidence of a bleak Black Friday for US retailers will keep the USD underpinned this week (but remain aware a larger bounce in equities may not be too far away). For EUR/USD, this suggests a visit to the recent lows of between 1.2300-1.2400 is likely before we see a rebound. * Danica Hampton is BNZ's Currency Strategist. All of the research produced by the BNZ Markets team of economists is available here.