Opinion: Markets think RBNZ will cut OCR by 125 bps

By BNZ Currency Strategist Danica Hampton NZD/USD edged higher last night, but spent most of the night within the familiar 0.5250-0.5350 range. Hopes for the creation of a US "bad bank" to mop up toxic assets and expectations the US$900b US fiscal stimulus package is close to being passed has buoyed investor confidence worldwide. Comments from ECB President Trichet dampening any expectations of a February rate also gave EUR an added boost. Solid gains across global equities and improved risk appetite saw currencies like EUR, GBP, AUD and NZD climb against the USD and JPY last night. The trimming back of short NZD positions from short-term speculative accounts saw NZD/USD climb above 0.5350 last night. The focus is now firmly on today's RBNZ decision (9:00am). We expect the RBNZ to cut at least 100bps to 4.00% and the accompanying statement to be consistent with the central bank easing further in the coming months. It's worth noting, while most economists are calling for 100bps today, many traders are looking for more aggressive action. Market pricing is consistent with the RBNZ cutting 125bps to 3.75% and the OCR troughing at 2.50% by mid-year.

Should the RBNZ disappoint (either by cutting 100bps and sounding cautious about further rate cuts or by cutting less than 100bps) expect to see a knee-jerk bounce in NZD/USD. However, we suspect any bounce will be short-lived. After all, the NZ economy is still struggling and yesterday's downward revision to Fonterra's payout for the 2008/09 season to NZ$5.10/kg has the potential to spark a significant contraction in NZ's rural economy. Should the RBNZ cut 125-150bps, expect NZD/USD to slip lower. However, given the global backdrop of a weaker USD and improving risk appetite, we're unlikely to see the currency crack below solid support in the 0.5150-0.5170 region today. The USD weakened against most of the major currencies last night as risk appetite improved and global equity markets chalked up gains. Hopes for the creation of a US "bad bank" to mop up toxic assets and Tuesday's US Senate move to widen the proposed stimulus package to nearly US$900b appear to have boosted investor confidence world wide. The FTSE climbed 2.4%, the German DAX climbed 4.5% and the S&P500 is currently up 2.38%. In currency markets, GBP/USD led the move, climbing from around 1.4150 to above 1.4350, bolstered by a continued recovery in UK banking stocks. EUR/USD received a bit of a boost following comments from ECB President Trichet and stronger than expected consumer confidence surveys from France, Germany and Italy. Trichet dampened any expectations of a February cut from saying the "next important meeting for the ECB will be in March". However, sovereign accounts were rumoured to be heavy sellers of EUR and EUR/USD struggled above 1.3300. The USD pared some of its earlier losses after the FOMC decision. As widely expected, the Fed left interest rates unchanged at 0-0.25%. The accompanying statement made it clear (i) the Fed is concerned about the US growth outlook; (ii) rates will remain near zero for some time; and (iii) the Fed will continue to pursue unconventional measures (like purchasing longer dated agency and mortgage assets). The Fed also noted it may extend these measures to include buying long-dated government debt. Swiss National Bank Chairman Roth said they were also ready to take unconventional measures, if necessary, to boost the economy. Last night's KOF leading indicator (if fell to -0.87 vs. -0.5 forecasts) confirmed the Swiss economy is facing a deep recession. While profit-taking on long USD positions and improving risk appetite has provoked a bit of USD weakness this week, we doubt EUR will benefit much. European sovereign debt concerns continue to weigh on EUR sentiment and this week's data has done nothing to dispel the view the Eurozone economy is slowing sharply and the ECB will have more work to do. While EUR/USD may nudge a little higher, the underlying trend will remain to the downside while EUR/USD trades below 1.3400. That said, currency markets will remain choppy as continuing bad news on economic activity from the end of 2008 weighs on investor risk-appetite but fresh policy action by governments and central banks keep some hope of economic recovery alive. * Danica Hampton is BNZ's Currency Strategist. All of the research produced by the BNZ Markets team of economists is available here.