NZ Consumer Prices (QoQ) (Q3) (21:45GMT,17:45ET)
Expected: 0.8%
Previous: 1.0%

NZ Consumer Prices (QoQ) (Q3) (21:45GMT,17:45ET)
Expected: 2.1%
Previous: 2.0%

How Will The Markets React?

Inflation pressures in New Zealand are expected to have held strong during the third quarter, as tight labor markets drive up wages and encourage domestic spending. Furthermore, rocketing food and energy costs are likely to fuel inflation as well, and consumer prices are estimated to have risen 0.8 percent from the second quarter, pushing the annualized rate up to 2.1 percent. Such an increase would be in line with central bank forecasts, as Reserve Bank of New Zealand Governor Alan Bollard said last month that CPI will accelerate to the top of the 1 – 3 percent target range by the end of 2007 and remain there until mid-2009. The situation has become somewhat dire in regards to inflation, as record-high interest rates of 8.25 percent may be unable to keep price growth under control. Furthermore, Finance Minister Michael Cullen has started to mull over introducing fiscal policies including tax cuts and increased government spending, which could fan inflation even further. The question is: can the RBNZ afford to raise rates even further? Given the potential for another round of monetary policy tightening to drive up the value of the New Zealand dollar even higher, the risks to export growth would likely be too large. However, if inflation growth starts to accelerate above the central bank’s target band over the course of the next year, RBNZ Governor Bollard may have no choice but start hiking rates again. As a result, if consumer prices for the third quarter prove to be stronger than expected, forex markets will likely respond in the sharpest manner and send NZD/USD higher.

Bonds – NZ 3-Month Government Bonds

New Zealand’s government bonds have done nothing but trend lower over the past year and a half, especially those with shorter-term maturities. Price action on the daily charts show the 3-month contract getting squeezed between channel resistance and trendline support, leaving it likely to break out. Upcoming economic data is expected to show that inflation pressures in the New Zealand economy continue to mount, which could lead traders to price in additional rate increases and take 3-month government bonds to break down through support at 91.27.

FX – NZD/USD

The combination of a return to carry trade buying along with rallies in commodities has helped push NZD/USD to retrace nearly 76 percent of the decline from 0.8110 – 0.6641. The pair has recently pulled back from resistance at 0.7760, though it is clear that the uptrend remains intact. However, the release of consumer price growth in New Zealand has the potential to shake NZD/USD up quite a bit, especially if the data deviates substantially from expectations. If CPI rises more than estimates, traders may start to speculate once again that the RBNZ will consider raising rates to yet another record high of 8.50 percent and push NZD/USD to break resistance and take on the 0.8000 level. However, if consumer price growth proves to be tepid, Kiwi could plunge towards trendline support near 0.7550 as investors will judge that the RBNZ’s ultra aggressive monetary policy tightening scheme earlier in the year has put a dent in inflation, and that economic expansion as a whole could be next.

Equities – NZX 50 Index

Similar to other global equity markets, the NZX 50 Index has rallied substantially since mid-August, but the record highs looming just above 4,333 have blocked any additional gains. If commodity prices continue to mount and traders remain risk seeking, the NZX 50 will likely take on the highs once again. However, if the release of NZ consumer prices shows that inflation pressures built up more than expected during the third quarter, speculation of additional rate increases down the line by the RBNZ could push equities lower. If such negative sentiment pervades the NZ equity markets, the index could break down through trendline support towards 4,230. However, if the data actually shows easing inflation, the NZX 50 rally could go on unfettered to target new record highs.

Terri Belkas is a Currency Strategist at FXCM.