Opinion: The RBA may not cut more than 50bps

By BNZ Currency Strategist Danica Hampton The NZD/USD traded choppily within a 0.6980-0.7070 range on Friday night as market participants digested a mixture of upbeat US data, weak USD equities and month-end fix flows. Weak Canadian GDP sent USD/CAD surging, which combined with buoyant US data (both Chicago PMI and the University of Michigan consumer confidence) tended to underpin the USD. Meanwhile, soft US stocks (US equity indices lost between 1.5-2.0%) and rising risk aversion sent JPY crosses south. NZD/JPY fell from around 77.00 to below 76.00 and NZD/USD finished last week around 0.7000. With little due out in NZ this week, events across the Tasman will probably be the main focus. While the RBA is widely expected to cut rates 25bps to 7.00% on Tuesday, with recent Australia data suggesting the economy is not slowing as sharply as many feared, market participants may be overestimating the scope of future RBA rate cuts. Over the weekend, an AFR article from noted RBA watcher, Alan Mitchell, conveyed a similar sentiment (suggesting that the RBA was unlikely to cut more than 50bps in total over the coming months). Should this week’s RBA statement temper easing expectations and Australian data (Q2 GDP is due on Wednesday) suggest the economy is holding up okay, this will likely help support AUD/USD. While a rebound in AUD/USD will likely provide a bit of a prop for NZD/USD, we would also expect to see renewed downward pressure on NZD/AUD. Over the coming week, we look for further consolidation in NZD/USD. We suspect bounces towards 0.7100 will attract sellers. Initial support is seen around 0.6970-0.6980 region, but dips below 0.6900 are unlikely to be sustained without a narrowing of NZ-US interest rate spreads, a slide in NZ commodity prices or a sharp spike in risk aversion. Majors The USD inched higher against most currencies on Friday as market participants digested a mix of upbeat US data and worried about the impact Hurricane Gustav may have on crude oil prices. While US economic news started off a little dreary (personal income -0.7% vs. -0.2% forecast and personal spending rose 0.2% on expectations), it soon improved. The Chicago PMI printed at 57.9 in August, well above forecasts of 50.0, and the University of Michigan consumer sentiment index climbed to 63.0 (vs. 62.0 forecast). EUR/USD slipped from above 1.4750 to below 1.4650 as the upbeat US data made a stark contrast to that out of the Eurozone. The EU Commission business climate indicator, which is closely related to industrial production, fell from -0.2 to -0.33 in August. The broader economic confidence measure dipped from 89.5 to 88.8 – its lowest level since March 2003. Over the weekend, worries that Hurricane Gustav (which strengthened to a Category 4 storm on Saturday) may threaten crude oil production brewed. While the US IEA has reassured the markets they stand ready to release crude reserves, any damage to Gulf of Mexico refineries will likely drive oil prices higher and weigh on the USD. While US markets will be closed on Monday for Labor Day, over the coming week investors will be tracking the weather (for its implications for oil prices), the US data and the upcoming central bank decisions. While the US economy is far from a picture of health, we can’t help but think the USD will come off looking the best of a bad bunch. After all, recent US data has tended to surprise on the upside, unlike data elsewhere in the world. Furthermore, while the latest FOMC minutes suggested the Fed is in no hurry to change interest rates, when the move finally occurs it will likely be higher. In contrast, the next interest rate move from the ECB and Bank of England will likely be lower, albeit neither is expected to move this week. The ECB is widely expected to keep rates steady at 4.25% on Thursday, but with the Eurozone economy already halfway to a formal recession the ECB’s optimism looks increasingly misplaced. The ECB will likely revise down its growth forecasts when it publishes this month, but with policy makers extremely worried about inflation rate cuts are unlikely until 2009. Overall, we suspect EUR/USD will struggle in the absence of a stock market plunge, a spike higher in crude oil prices or a disastrous US non-farm payrolls number (due September 5) * Danica Hampton is BNZ’s Currency Strategist. All of the research produced by the BNZ Markets team of economists is available here.