Opinion: NZ$ treads water as Euro hangover settles after party; China inflation a worry

By Mike Jones The NZD/USD has spent the last 24 hours consolidating in a 0.7160-0.7240 range. After the vicious volatility of the past few days, financial markets paused for breath last night. In Europe at least, the mood was akin to the hangover after the party, as some of the initial optimism over the EU-IMF rescue package faded. A mix of commentators from the IMF and the ECB cautioned the rescue deal is only a temporary fix, with the real treatment yet to come. As a result, European stocks pared some of the previous day’s gains and EUR/USD slipped back below 1.2700. While speculative and commercial accounts continue to show solid demand for NZD/USD and AUD/USD on dips, last night’s generally dour mood kept investors’ risk appetite subdued, limiting NZD/USD gains to the 0.7220 region. Yesterday’s slew of Chinese data didn’t disappoint. Both retail sales and industrial production maintained their 18-19%y/y growth pace in April. However, markets were more concerned with signs of a pick-up in Chinese inflation pressure (April CPI +2.8% vs. 2.7% expected). Fears rising inflation will see China take further action to slow demand weighed on commodity prices and ‘commodity-linked’ currencies like the NZD last night. Still, most of the attention was on GBP, and the likely shape of the next UK government. Optimism a Conservative-Liberal Democrat coalition government would be announced saw GBP head higher, and NZD/GBP tumbled back towards 0.4800. With David Cameron (the Conservative Leader) recently confirmed as the new UK prime minister, we suspect a test of 0.4750 in NZD/GBP is likely in coming sessions. Looking ahead, the local data calendar is relatively light until Q1 retail sales on Friday. As such, developments in Europe will continue to provide most of the direction for NZD/USD this week. Initial support is expected on dips towards 0.7140. Resistance is at 0.7230. Majors The USD strengthened against most of the major currencies overnight as caution returned to currency markets. After the ebullience of the previous day, markets spent most of last night ‘sobering up’. Most notably, EUR lost some of its gloss, and European equities fell, as doubts about the ability of the EU-IMF rescue package to address the sovereign debt crisis returned. The EUR/USD slipped from 1.2800 to below 1.2700, and the Eurostoxx 50 index declined 1%. Germany’s cabinet approved their (£123b) share of the European rescue package. However, ECB Governing Council member Wellink said “the safety net has a temporary nature”, which tended to undermine confidence, as did a warning from the IMF that the £250b earmarked for the bailout fund is a “hypothetical” figure only. Providing further headwinds for the EUR, markets have pushed back the expected timing of the first ECB interest rate hike to February 2011. With the weaker EUR paving the way for a firming in the USD, most of the major currencies edged lower overnight. Sentiment towards ‘commodity-linked’ currencies like NZD and AUD wasn’t helped by a relatively lacklustre night in commodities markets. Oil prices dipped 1%, and the CRB index tracked broadly sideways. While yesterday’s Chinese data showed economic activity racing ahead, it was the stronger-than-expected inflation figures that really caught markets’ eye. Fears China may take further steps to slow Chinese demand weighed on commodity prices overnight. GBP was the star performer last night as UK coalition talks appeared to edge closer to resolution. A spokesman for the Labour party said talks between the Labour Party and Liberal Democrats (LDs) were "temporarily" over. Speculation that this would pave the way for a deal between the Conservative Party and the LDs (which is regarded as the best option for getting the UK’s budget deficit under control) lit a rocket under GBP. Indeed, GBP/USD jumped 2c to almost 1.5000 in the space of two hours. Last night’s UK data also buoyed optimism about the strength of the UK recovery. March’s industrial production and manufacturing production figures both outstripped analyst forecasts by a clear margin. Looking ahead, while the EU’s rescue package has soothed immediate concerns over a European sovereign default, sentiment remains fragile and structural issues remain. As such, we suspect rallies in EUR/USD will continue to be sold. Short-term support is eyed towards 1.2610 with initial resistance at 1.2800. *All of the research produced by the BNZ Capital team of economists is available here