July 25 RBNZ Rate Decision (17:00 ET; 21:00 GMT)
Expected: 25bp Hike To 8.25%
Previous: 25bp Hike To 8.00%

How Will The Markets React?

The Reserve Bank of New Zealand surprised economists when they lifted interest rates 25 basis points to a new high of 8.00 percent in June. This was the third consecutive rate hike, taking the country’s rates to the second highest levels in the industrialized world – second only to Iceland. The increase caught economists off guard, but confirmed what the markets had expected. Looking to the next meeting on July 25th, projections are once again diverging. Analysts seem somewhat skeptical of a fourth consecutive boost in interest rates but interest rate swaps are pricing in a 66 percent of a 25 basis point boost by. The policy statement after the June 7th meeting clearly left the door open for another hike citing the threat that consumer spending and housing demand poses for inflation. However, the combination of RBNZ Governor Alan Bollard’s aggressively hawkish stance along with stronger-than-expected retail sales and CPI data has driven the New Zealand dollar to 22-year highs, leaving businesses, particularly exporters, to suffer. Given the RBNZ’s efforts to deflate the national currency through intervention, it is clear that they are willing to take alternative paths from the monetary policy playbook in order to keep the pressure on inflation. In fact, NZ Finance Minister Michael Cullen said recently that he couldn't rule out using powers in the Reserve Bank Act to suspend the central bank's agreement on how it combats inflation. With the RBNZ rate decision clearly a major issue for the country, the central bank’s actual rate decision will garner major attention in bond, forex, and equity markets.

Bonds – 10-Year New Zealand Government Bond Futures

Prices on New Zealand government bonds have steadily declined as a hawkish RBNZ has led traders to continue pricing in higher interest rates. This time around is unlikely to be very different, as the central bank is anticipated to raise rates for the fourth consecutive month to a record high of 8.25 percent, which could lead contracts to drop to the 93.13 level. However, if we see that the bank surprises the markets and leaves rates steady, or if they hike rates but signal a far more neutral tone, NZ bonds may actually start to climb up towards 93.35.

FX – AUD/NZD

AUD/NZD has remained in a steady downtrend, especially as markets speculate on the possibility of a hike by the Reserve Bank of New Zealand to another record of 8.25 percent on Wednesday evening (17:00 EST; 21:00 GMT). However, the release of Australian consumer price data on Tuesday evening (21:30 EST; 01:30 GMT) could shake up the pair a bit, especially if the reading differs from expectations. Should we see a greater-than-predicted report, Australian dollar strength could take AUD/NZD back up to the 1.1000 level. On the flip side, softer inflation readings will only allow the pair to dip further, as the chances of a rate increase by the Reserve Bank of Australia this year will be slashed. Furthermore, the New Zealand dollar is likely to garner a good amount of strength ahead of the expected RBNZ rate hike. Thereafter, though, AUD/NZD could see a bounce, as growth prospects for the Australian economy remain to the upside, while aggressive monetary policy by the RBNZ has created the potential for a sharp slowdown for the New Zealand economy.

Equities – NZX 50 Index

New Zealand’s benchmark index closed up 14.75 points, or 0.3 percent, at 4321.29, despite news that Dubai Aerospace Enterprise’s takeover bid for Auckland Airport needs to pass strict tests of government approval. Given the strategic importance of New Zealand’s main gateway, the NZ$2.3 billion bid for a majority stake in Auckland International Airport Ltd will be reviewed by New Zealand government to ensure compatibility with national interests. After posting gains of 10 cents yesterday on takeover speculation, the shares of Auckland International Airport declined 2 cents to NZ$3.39 at the close of Tuesday’s trading session. The losing streak in the stocks of manufacturers of export products continues in tandem with the Kiwi dollar’s ascent to one fresh post-float high after another. Meanwhile, shares of Fisher & Paykel Appliances eased back 14 cents to NZ$3.65.

The NZX 50 index could drop sharply towards the 4,250 level on the RBNZ rate decision, as another rate hike that would push up borrowing costs and possibly lead the New Zealand dollar to appreciate further has the potential to severely hurt businesses. On the other hand, if the central bank opts to take a more neutral route and leaves the overnight borrowing rate at 8.00 percent, equities would likely rally to at least 4,350.

Terri Belkas is a Currency Strategist at FXCM.