After leaving interest rates unchanged at 2.50% in the latest meeting, the Reserve Bank of New Zealand continues to exhibit a strongly dovish bias, issuing additional warnings on troublesome external conditions. The Central Bank remains cautious in its attitude as falling commodity prices coupled with lackluster inflation may drive further policy decisions over the near-term as it works to fulfill its own mandate. Coming on the heels of the Federal Reserve decision to leave US interest rates unchanged at 0.50% and a slightly dovish tone from the FOMC, the NZDUSD pair has begun to recover from some of the previous sessions losses. The possibility of the Fed holding off on further rate hikes was enough to dent momentum in the US dollar in spite of the fact that the RBNZ is forecast to ease monetary policy further to keep the economy competitive and push inflation back towards target.

The Fundamental Picture

The New Zealand economy has undergone a notable devaluation in the last year as super-accommodative actions on the part of the RBNZ saw interest rates slashed 100 basis points from the 3.50% reported a year ago. As policymakers work frantically to fight off deflation and weaker commodity export prices, the Central Bank was forced to enter the currency war, even if not formally engaging in outright devaluation. Dairy, one of the cornerstones of the New Zealand export economy, has seen prices fallen dramatically over the last year, forcing a reaction. A rapid devaluation and slipping demand from China, New Zealand’s single largest trading partner have added to concerns piling up for Central Banker Graeme Wheeler.

The impact of weaker dairy prices and other falling commodity prices has been the slow infiltration of deflationary forces and disinflation. In his latest statement released overnight, Reserve Bank Governor Wheeler underlined the impact of weaker energy prices as a consistent drag on inflation returning to the 1.00-3.00% targeted by policymakers. At present, headline CPI is sitting at 0.10% on an annualized basis, well below desired levels. While core inflation is at 1.60% thanks to more volatile components being stripped from the measure, the Central Bank currently expects challenges to headline CPI returning to the objective by the end of 2016 as previously forecast. Moreover, lower rates have stoked risks in the housing sector, with rising prices in major cities potentially threatening to derail economic stability.