NZD tumbles amid dovish RBNZ

The New Zealand dollar tumbled 1.20% during the Asian session after the RBNZ surprised the market with a dovish statement. The Kiwi slid to 0.6718 against the greenback, its lowest level since June 3rd last year. The central bank held the Official Cash Rate (OCR) at record low 1.75%, as broadly expected by market participants. The disappointment stems from the fact that Governor Wheeler failed to acknowledge the recent positive developments in both inflation levels and the Kiwi trade-weighted value (-5% since the February meeting).

Inflation forecast was revised to the upside with the headline measure expected to hit 2.1%y/y in the third quarter before easing toward 1.1% in the first quarter of 2018. The RBNZ justified its decision by stating that the recent pick-up in consumer prices “was mainly due to higher tradable inflation, particularly petrol and food prices” and added that “the level of core inflation has generally remained low”. Those elements suggest that the RBNZ is in no hurry to increase borrowing cost.

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In our view, the central bank is simply playing for time, waiting for the Fed to tighten further its monetary policy before making a move. Historically, as a commodity producer country, New Zealand is used to deal with stronger inflationary pressure – remember the RBNZ has a target band of 2% +/-1%. Looking at the current inflation picture, it is obvious that the RBNZ as time to see it coming. Meanwhile, it will continue to emphasize the strength of the Kiwi, which is weighting on tradable inflation.

NZD/USD is currently testing the key support area at around 0.6800-80 (previous lows). A clear break of this area is needed to trigger a sell-off in the Kiwi. We do not rule further NZD weakness, especially given the recent pick-up in US treasury yields, while Kiwi’s ones have been moving lower consistently since the beginning of the year.

HKD weakens further

The long USD short HKD trade continues uninterrupted, clearly having no fears of preemptive official intervention at this point. USDHKD increased to 7.7891 in Asian trading well below the Hong Kong Monetary Authority’s 7.85 upper band (7.75 to 7.85 convertibility range). HKMA has expressed commitment to the USD linked exchange rate (expected to intervene at 7.8), yet the rapid HKD deprecations spawn questions about the sustainability of the peg. The widening US-HK interest rate differential makes borrowing cheap in HK and buying in US a tempting candidate for carry traders. Concerns over Hong Kong’s attempt to slow house price appreciations on tighter lending practices and increase in purchase tax has pushed Hibor (1-month Hibor 0.38 from 0.75 in Jan) below the US equivalent while high levels of interbank liquidy lower demand for HKD.

In addition, China’s is also in the process of tightening of financial conditions and expectations of gradual Fed interest rate increases and reduction in balance sheet are all generating excessive outflows. However, the hazard of waiting is that speculative short selling of HKD could complicate the HKMA objective and even threaten the stability of the banking system. Waiting could force the HKMA to intervene but possibly raise interest rates. Given the high level of leverage in Hong Kong house holds a sharp rate increase would pressure debt holder and constrict consumptions, a dangerous spiral. Currently give the manageable fundamental backdrop and the HKMA massive $3.5 trillion reserves we see no threat to the USD peg.

BoE to keep rates unchanged today

Today the Bank of England will decide about its interest rate that should likely remain around 0.25% against the backdrop of political uncertainties. Indeed, the 8th of June New General Election will take place, after Theresa May asked the Queen Elizabeth to dissolve the parliament. UK Prime Minister is attempting to gain a stronger majority before negotiation on the article 50 with the EU.

This is why the British central bank should favour today the wait-and-see mode. Political uncertainties regarding the 2-year negotiation period prevail. Anyway, the BoE has gained some time since last year as the UK economy had clearly benefited from pound devaluation after the Brexit vote. The inflation is now standing at 2.3% y/y. Yet the growth seems still a bit slow (0.3% for Q1 GDP). The unemployment rate keeps declining and is now standing at a 12-year low.

However, there is one important thing to be said, the UK trade deficit is still very large despite the weak pound. The trend is clearly negative and amounts for £3.6 billion. We believe that, even though the weak pound is helping the economy, it also means that the overseas demand is falling for UK goods certainly on fears that the trade relations with the UK are unclear at the moment.

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