Inflation Versus Exchange Rate: RBNZ Between a Rock and a Hard Place

The past week has witnessed tension mount in advance of the RBNZ official cash rate announcement due at 1700 GMT, and as a consequence market sentiment has vacillated from bullish to bearish, sending the Kiwi past 0.8100 USD and back.

[B][U]Headlines[/U][/B]
[B]Speculation Runs Rife In Advance of RBNZ?s Rate Decision Today[/B]
Analysts and investors are feverishly trying to second-guess the next interest rate decision of the Reserve Bank of New Zealand, due to hit the wires today at 1700 GMT. According to a key Credit Suisse index based on overnight trading in interest-rate swaps, the probability of a 25 basis points hike in the OCR is 61 percent, up from 24 percent prior to the release of data on retail sales and quarterly inflation.
http://www.bloomberg.com/apps/news?pid=20601081&sid=aphBVKOHJpWM&refer=australia
[I]Source: Bloomberg[/I]
[B]Political Pressure Builds On As Concerns over Economic Conditions Escalate[/B]
National and New Zealand First, New Zealand?s political parties, are placing increasing amounts of pressure on the government - in particular Prime Minister Helen Clark, and Finance Minister Michael Cullen - to stem the surge in the Kiwi currency exchange rate.


[I]Source: The New Zealand Herald[/I]
[B]Surge in Commodity Prices Boosts Fonterra Payout Above Forecast[/B]
A press release by Fonterra, New Zealand?s largest dairy manufacturer with 11,600 farmers on its payroll, confirmed that the payout for milk solids for the year ended May 31, 2007 peaked to NZ $4.46/kg, above the forecast of $4.35/kg. Given the surge in world prices of dairy commodities, the preliminary estimate for next season is NZ $ 5.53 per kilogram of milk solids.
http://www.scoop.co.nz/stories/BU0707/S00475.htm
[I]Source: Scoop[/I]
[B][U]Market Activity[/U][/B]
[B]Currency Market - NZD:[/B]
The past week has witnessed tension mount in advance of the RBNZ official cash rate announcement due at 1700 GMT, and as a consequence market sentiment has vacillated from bullish to bearish, sending the Kiwi past 0.8100 USD and back. The Wellington trading session mirrored increasing concerns that the central bank may not raise rates and instead succumb to pressure to stabilize export demand. Trading was choppy as the New Zealand dollar dropped to 0.8035 USD during early trading, recovered to 0.8057 USD at the close of the Wellington session.
The Aussie gained strength against the Kiwi after quarterly inflation printed at an above-expectations level of 1.2% - the AUDNZD pair declined to 0.9094 AUD from 0.9145 AUD at Tuesday?s close in Wellington. News of deep-rooted troubles in the US credit markets sparked a rise in global risk-aversion and led investors to trim risky bets financed by the popular Japanese yen and New Zealand dollar carry trade. The NZDJPY cross dropped from 96.98 to settle around 96.50
The market is unlikely to be surprised by further monetary tightening, or a hawkish inflationary stance at the very minimum, and news on US credit market and Japanese carry trade unwinding may prove market-moving.
[I]NZDUSD (Daily Chart)[/I]


[I]Source: Bloomberg
[/I]
[B]Equity Market - NZSX-50 Index:

[/B]New Zealand?s stock market remained resilient against the downward spiral in global equities triggered Tuesday by news of continuing subprime lending troubles at Countrywide Financial, the largest mortgage lender in the US. New Zealand?s bourse also maintained strong footing despite speculation over the possibility of another hike in the official cash rate by RBNZ. Advances by domestic stocks enabled the benchmark NZSX-50 index to close up 3.68 points at 4324.97 on turnover of NZ $202 million. Exchange operator NZX gained 10 cents to close at NZ $1160 after a June earnings report indicated that half-year net profit surged to NZ $4.21 million. As the Dubai Aerospace Enterprise takeover bid is now a subject of extraordinary due diligence, Auckland Airport stock dropped 1 cent to NZ $338 on heavy turnover.
NZSX-50 Index (Daily Chart)


[I]Source: Bloomberg[/I]
[B]Fixed-Income Market - 10-year Government Bonds:[/B]
The fate of New Zealand?s market for fixed-income government debt hangs in the balance in advance of the central bank?s quarterly monetary policy review and overnight lending rate decision. 10-year bond yields rose by 10 basis points to 6.843 percent on Wednesday. The uptrend in yields on benchmark 10-year notes witnessed last week may not be repeated if the Reserve Bank succumbs to pressure to curtail the exchange rate, and hence adopts a less hawkish stance on inflation.
[I]10-year Government Bonds (Daily Chart)


Source: Bloomberg[/I]