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NZD falls to 11-month low, BoE in focus
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 3 last year. The central bank held the Official Cash Rate (OCR) at a record low of 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).
The 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 tradables 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 costs.
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 dealing 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 has time to see it coming. Meanwhile, it will continue to emphasise 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 is also in the process of tightening 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 households, a sharp increase in interest rates would pressure debt-holders and possibly constrict consumption (pressuring growth), a dangerous spiral.
Currently given the manageable fundamental backdrop and the HKMA’s massive $3.5 trillion reserves, we see no threat to the USD peg.
BoE to keep rates unchanged, fears over UK trade deficit
Today the Bank of England will likely decide its interest rate should remain at 0.25% against the backdrop of political uncertainties; the June 8 General Election taking place and the Prime Minister attempting to gain a stronger majority before negotiating on Article 50 with the EU.
This is why the British central bank should favour a wait-and-see mode today. Political uncertainties regarding the two-year negotiation period prevail and the BoE has gained some time since last year as the UK economy has clearly benefited from pound devaluation after the 2016 Brexit vote.
Inflation now stands at 2.3% y/y, yet growth still seems a bit slow (0.3% for Q1 GDP). The unemployment rate keeps declining and is now 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 overseas demand is falling for UK goods, certainly on fears trade relations with the UK are unclear at the moment.