Goldman Sachs expects the New Zealand dollar to remain under pressure as the Reserve Bank of New Zealand (RBNZ) maintains a dovish posture in advance of next weeks policy decision. The investment banks analysis points to a domestic policy environment that is unlikely to provide support for the currency even as global financial conditions evolve.
In a recent speech, RBNZ Governor Breman said the central bank would "look through" the initial effects of the recent oil price shock, and emphasized that remaining slack in the economy should reduce the risk that short-term supply-side price increases become embedded in medium-term inflation expectations. Headline inflation in New Zealand has been running close to 3%, which sits at the top of the RBNZs target range.
Goldman notes that New Zealands labour market has softened the most among G10 economies. The RBNZ is expected to stress that this labour-market weakness will help limit second-round inflation effects, even though projections for year-ahead inflation have edged higher. In this context, Goldmans view is that without a shift toward tighter domestic policy, the New Zealand dollar will continue to move broadly in line with U.S. yield dynamics.
Using its clustering framework and recent analysis of how foreign-exchange rates react to tighter financial conditions, Goldman argues the New Zealand dollar remains exposed to the twin risks of higher yields and downside growth pressures. The bank points to ongoing upward pressure on oil prices as an additional weakening force for the currency, despite the fact that the recent rise in 10-year yields has been driven by inflation considerations.
Markets have shown limited evidence of pricing in a significantly larger hit to global growth, Goldman adds. Nevertheless, the firm expects the New Zealand dollar to face continued strain from the combination of rising yields and an overall tightening in financial conditions.
Key points
- Goldman Sachs anticipates further New Zealand dollar weakness amid a dovish RBNZ stance and limited domestic policy support - impacts the foreign exchange market and bond markets.
- RBNZ Governor Bremans intention to "look through" first-round oil-price effects, combined with an economy showing slack, reduces the chance of persistent medium-term inflation - relevant to inflation-sensitive sectors and monetary policy expectations.
- Rising global yields and persistent oil-price pressure create downside risks for the currency, with tightening financial conditions weighing on growth-sensitive assets and markets.
Risks and uncertainties
- The RBNZs dovish approach may limit policy measures that could support the New Zealand dollar - a risk for FX traders and fixed-income investors.
- Higher yields and tighter financial conditions could exert further downward pressure on the currency and pose downside risks to growth-sensitive markets.
- Persistent upward pressure on oil prices may continue to push inflation and influence yields, adding complexity to monetary-policy and market responses.