New Zealand Dollar stalls below 0.5700 amid Oil-driven weakness in risk appetite

Gains in NZD/USD remain modest on Friday, with the pair confined to its range below 0.5700 so far.
The Kiwi has gained support this week from diverging RBNZ and Fed monetary policy prospects.
Support for the US Dollar from risk aversion is being countered by a sharp reversal in US Treasury yields.

Modest gains in the New Zealand Dollar (NZD) against the US Dollar (USD) on Friday have left the pair within Thursday’s trading range, as fresh five-month highs in Oil prices keep sentiment moderately risk-averse. Trading around 0.5690, NZD/USD remains just shy of the one-month high of 0.5710 reached earlier this week, although its upward momentum is weakening.

Expectations of an interest rate increase at next week’s Reserve Bank of New Zealand (RBNZ) monetary policy meeting have strengthened, placing the Kiwi among this week’s best-performing major currencies. A weaker exchange rate and the energy shock have raised the near-term inflation outlook, fuelling those expectations.

TMGM Analysis: Financial Market News, Economic Calendar & Market Insights

Friday has nevertheless brought a deterioration in risk appetite, with escalating Middle East tensions driving Oil prices upwards. Brent Crude climbed above $110.00 a barrel to five-month highs on Friday. Alongside lifting global inflation, this is leaving Crude-importing economies such as New Zealand more exposed, potentially creating a serious challenge for the RBNZ.

Are falling US Treasury yields holding back USD rallies?

Despite this week’s risk aversion, the US Dollar has received little meaningful support. With US Treasury yields reversing recently, investors have abandoned expectations of a Federal Reserve (Fed) interest rate increase next week and are reassessing the overall extent of the tightening cycle, keeping the Greenback under pressure.

Investors seeking the safety of US Government bonds amid mounting concerns over AI-sector profitability have driven a steep fall in long-term US bond yields this week. That decline has reduced pressure on the central bank to raise interest rates.

Later on Friday, the preliminary US S&P Global Purchasing Managers' Index (PMI) readings will offer an indication of business activity strength. Their effect on the US Dollar is likely to remain limited, however, since they will not alter the outlook for the Fed’s next monetary policy meeting.

Key questions on the RBNZ

What role does the Reserve Bank of New Zealand play?

As New Zealand’s central bank, the Reserve Bank of New Zealand (RBNZ) has economic objectives that include achieving and preserving price stability, alongside supporting maximum sustainable employment. Price stability is achieved when inflation, as measured by the Consumer Price Index (CPI), is within the 1% to 3% band.

How is the New Zealand Dollar affected by the Reserve Bank of New Zealand’s monetary policy?

To meet its objectives, the Reserve Bank of New Zealand’s (RBNZ) Monetary Policy Committee (MPC) sets the appropriate Official Cash Rate (OCR). If inflation exceeds the target, the bank seeks to curb it by increasing the OCR. This raises borrowing costs for households and businesses, slowing economic activity. The higher yields associated with higher interest rates generally support the New Zealand Dollar (NZD), as they make the country more attractive to investors. Lower interest rates, by contrast, usually put downward pressure on NZD.

Why is employment important to the Reserve Bank of New Zealand?

A tight labour market can drive inflation higher, which explains why employment matters to the Reserve Bank of New Zealand (RBNZ). Its goal of “maximum sustainable employment” refers to the greatest use of labour resources that can be maintained over time without accelerating inflation. The bank explains: “When employment is at its maximum sustainable level, there will be low and stable inflation. However, if employment is above the maximum sustainable level for too long, it will eventually cause prices to rise more and more quickly, requiring the MPC to raise interest rates to keep inflation under control,”

How does Quantitative Easing (QE) work?

When conditions are extreme, the Reserve Bank of New Zealand (RBNZ) can turn to a monetary policy tool known as Quantitative Easing (QE). Under QE, the RBNZ prints domestic currency to purchase assets, generally government or corporate bonds, from banks and other financial institutions. The purpose is to expand the domestic money supply and stimulate economic activity. A weaker New Zealand Dollar (NZD) is the usual outcome. Used as a last resort when interest rate reductions alone are unlikely to meet the central bank’s objectives, QE was deployed by the RBNZ during the Covid-19 pandemic.