New Zealand Signals First Rate Cuts Since 2003

The Reserve Bank of New Zealand (RBNZ) validated market expectations today, confirming interest rates would remain at the record 8.25% level. Bank Governor Alan Bollard justified the action with a prediction that inflation would reach as high as 4.7% in the third quarter, noting that 'although much of this reflects higher food and energy prices, underlying inflation pressure also remains persistent.' Bollard made a direct reference to stagflation, saying that the combination of price pressure from booming commodities coupled with a global credit crisis and slumping housing markets is 'producing a challenging environment of weak activity and high inflation.' The bank slashed growth expectations from its previous assessment, noting GDP expansion would be next to nil this year followed by a modest recovery in 2009.

That said, Bollard was optimistic in the medium term inflation outlook, saying that the RBNZ still expects an easing in input costs and the global slowdown to bring prices into the bank's comfort range. In fact, Bollard was so confident that prices would come down that he expected to be able to cut rates by the end of this year, a marked departure from any RBNZ policy statement in recent memory. Specifically, the last time the RBNZ cut rates was in September of 2003.

The New Zealand dollar reacted strongly to the announcement, plunging 86 pips in the first ten minutes following the release. Two weeks ago we noted a downward sloping channel guiding NZDUSD lower. We identified a Hammer candlestick at support that was subsequently confirmed by a Long White Candle. We expected retracement to the channel boundary in the near term, looking to short the pair here as the downtrend resumes (see article). Last week saw our analysis materialize as NZDUSD rallied sharply to stop right at the channel top. Price action then showed the Three Outside Down candlestick formation, a strong bearish signal. Writing on Sunday of this week, we advocated a short below 0.7860 targeting 0.7560 with a stop-loss at 0.7970 (risking 110 pips to gain 300).

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