Softer Q3 inflation data weigh on New Zealand Dollar

• Q3 CPI inflation eased to 3.7%, below market expectations, weighing on the New Zealand Dollar.
• With inflation still above the RBNZ’s target, expectations of a rate rise next week remain strong.
• Further NZD/USD declines may be contained by weak US housing figures and uncertainty over Fed rates.

New Zealand’s annual Consumer Price Index (CPI) inflation slowed to 3.7% in the third quarter from 4.1% in the previous period, according to Statistics New Zealand, coming in slightly below the market forecast of 3.8%. The softer-than-expected release put the New Zealand Dollar (NZD) under pressure, with NZD/USD ending a five-day run of gains and trading near 0.5700 during Thursday’s European session. Quarter on quarter, the CPI increased by 0.7%, a marked deceleration from the second quarter’s 1.5% rise and short of the 0.8% expected.

Although inflation has eased, it continues to exceed the top of the Reserve Bank of New Zealand’s (RBNZ) target band. That persistence underpins expectations of additional monetary tightening. Markets are currently assigning nearly a 98% probability to a rate increase at the forthcoming meeting and a 100% probability to cumulative rate rises of 50 basis points by the end of February.

Persistent NZ inflation underpins RBNZ tightening expectations and Kiwi support

Market pricing continues to point firmly towards further tightening, according to strategists at Brown Brothers Harriman, who say that “above target inflation argues for additional RBNZ rate hikes and offers NZD support,” and observe that “the swaps curve prices in 80% odds of a 25bps RBNZ rate hike to 3.00% on October 28,” highlighting expectations of continued policy normalisation by the central bank as price pressures persist.

Signs of weakness in the United States economy continue to weigh on the US Dollar (USD), potentially curbing further losses in NZD/USD. Recent releases recorded a decline in September housing starts, while pending home sales fell to a record low. The CME FedWatch Tool also shows traders assigning an 87% probability to the Federal Reserve leaving rates unchanged next week and an 86% chance of an increase in December. Uncertainty nevertheless remains high after Fed Chair Kevin Warsh refrained from offering clear guidance on subsequent rate changes.