RBNZ Holds Rates, What Now?

In its latest meeting, the Reserve Bank of New Zealand (RBNZ) chose to keep the benchmark rate at 2.50% for the eleventh straight month. According to the RBNZ, the decision was mainly because of the risks associated with the euro zone crisis and the low inflation outlook.

For instance, the outlook on New Zealand’s major trading partners in the euro zone remains very bleak. Most of them are in recession and there remains the risk that conditions could deteriorate even further.

Meanwhile, the country’s annual inflation rate is currently only at 1.0%, which is at the bottom of the RBNZ’s 1% to 3% inflation target. The inflation rate is also at its lowest pace in 13 years.

Internally, New Zealand seems to be doing well. Bollard said in the accompanying statement that economic activity is projected to grow modestly. The housing market, which the central bank had been worried about in the past, is now improving. Bollard also said that the Christchurch earthquake has boosted the construction sector due to all the new repair projects.

The decision wasn’t unexpected though, as most economists predicted the central bank to keep rates unchanged. From the tone of the statement, it seems that the central bank is in no rush cut rates. In fact, some economists are even predicting that the bank could raise interest rates in March 2013.

Of course, there are many external factors that can cause the RBNZ to change its mind.

First, there’s the ever-present euro zone debt crisis.

The spotlight has been bouncing back and forth between Spain, Greece, and Italy and it seems that the situation is only getting worse. As I mentioned earlier, euro zone countries are some of New Zealand’s major trade partners. If the debt crisis worsens, it could negatively affect demand for New Zealand’s exports. This in turn could force the RBNZ’s hand and cause it to implement additional easing measures.

Secondly, we also have to keep in mind what the major central banks are doing right now.

This past month, the European Central Bank and the Bank of England both implemented easing measures to inject liquidity into the markets. The ECB cut rates by 25 basis points and slashed deposit rates down to 0%. At the same time, the BOE expanded its asset purchase program by an additional 50 billion GBP.

Meanwhile, the RBNZ’s brother from across the Tasman Sea, the Reserve Bank of Australia, has aggressively been cutting rates since late last year. Also, let’s not forget that the Federal Reserve may soon introduce QE3 as well.

Remember, central banks normally act in unison with regards to monetary policy. They normally coordinate with one another in order to avoid imbalances in the global market. With the ECB, BOE, RBA and possibly the Fed also pushing forward with looser monetary policy, the RBNZ may eventually give in to peer pressure.

Going forward, it seems that NZD/USD may lack a clear trend and could continue to stick within a range.

NZD/USD Daily Chart

On one hand, New Zealand’s economy is performing better than other nations. This is attracting foreign investments and giving the Kiwi some support.

On the other hand though, many major economies are still struggling, with some still stuck in recession mode. This is causing a lot of uncertainty in the markets and holding back higher-yielding currencies like the Kiwi from rallying.

This contrast between fundamentals and overall sentiment makes me believe that we could see NZD/USD simply remain within range in the short-term.