2012 Forecast: NZD To Outperform USD And AUD Due To Rate Differential

It's likely that the RBNZ will stand on the sideline for most of this year. Without much change in monetary policy, the movement of New Zealand dollar will be more dependent on external factors including the US fiscal consolidation and sovereign debt problems in the Eurozone. Should the RBNZ adjust its monetary policy, it would likely be a rate hike as policymakers have to normalize its 'emergency' policy setting. This compares with a potential rate cut from the RBA. Against this backdrop, we expect NZD to outperform AUD this year.

Domestic economic developments have shown downside risks since late last year. GDP grew +0.8% q/q in 3Q11, following a +0.1% rise in the prior quarter, as driven by the Rugby World Cup visitor spending and agricultural manufacturing production. However, recent indicators have suggested that growth in 4Q11 probably softened and this might carry on to 1Q12. The country's unemployment rate remained stubbornly high, rising to 6.6% 3Q11 from 6.5% in 2Q11. Moderating business sentiment indicated that downside risk of the labor market remains. Headline CPI fell sharply -0.3% q/q, after rising +0.4% a quarter ago. On annual basis, inflation eased to +1.8% from +4.6% in the prior quarter. A rising unemployment rate should limit wage growth, thus retaining subdued underlying inflation.

At the January RBNZ meeting, policymakers decided to leave the OCR unchanged at 2.5%. Moreover, it was mentioned in the statement that 'given ongoing uncertainty around global conditions and the moderate pace of domestic demand, it remains prudent to keep the OCR on hold at 2.5%'. With 'for now' missing in the January statement, it indicated that the central bank will now keep interest rate unchanged for a longer period than previously anticipated. As such, it's prudent to expect the RBNZ will not alter its monetary policy for most of the time in 2012.

From the perspective of interest rate differential, NZD should strengthen against USD given the increasing opportunity of QE3. A similar story happens in AUDNZD. There have been increasing speculations that the RBA will lower interest rates further to stimulate the Australian economy. Whether the RBA would implement a rate cut depends on the Australia's inflationary outlook as well as the global economic prospect. Although core inflation in the second half of last year has been revised higher, it is still low and sits comfortably within the central bank's medium-term inflation target of 2-3%. This gives the RBA flexibility to loosen further. Therefore, we expect NZD will also outperform AUD in 2012.