New Zealand Dollar Slides as RBNZ Signals Cautious Rate Path

Key Moments

NZD Under Pressure After RBNZ Decision

The NZD/USD pair is trading lower by 0.7% near 0.6000 in the Asian session on Wednesday following the latest monetary policy decision from the Reserve Bank of New Zealand (RBNZ).

The New Zealand Dollar has come under notable selling pressure after RBNZ Governor Anna Breman pushed back expectations for near-term interest rate increases during her first press conference, which followed the decision to leave the Official Cash Rate (OCR) unchanged at 2.25%, in line with prior expectations.

Breman Pushes Back on Aggressive Hike Expectations

Governor Breman signaled a cautious stance on tightening policy, tempering market expectations that had built ahead of the announcement.

“Not planning to hike until we see a stronger economy, more inflationary pressure,” Breman said, and added, “There is possibility of rate hike by end of year.”

Her remarks contrasted with what some market participants had anticipated. Analysts at ING wrote in a report that they expected the New Zealand central bank to implement two rate hikes in the third quarter this year.

Dollar Firms Ahead of FOMC Minutes

On the US side, the Dollar is trading slightly higher as investors await the release of the Federal Open Market Committee (FOMC) Minutes from the January policy meeting, due during the North American session.

The US Dollar Index (DXY), which measures the Greenback against six major currencies, is up 0.1% and trading near 97.20 at the time of writing.

During the January meeting, the Federal Reserve announced a pause in its monetary easing cycle and indicated that future policy decisions will be driven by incoming economic data.

RBNZ: Mandate, Policy Tools, and NZD Implications

The Reserve Bank of New Zealand is the country’s central bank, tasked with achieving and maintaining price stability and supporting maximum sustainable employment. Price stability is defined as keeping inflation, measured by the Consumer Price Index (CPI), within a 1% to 3% band.

The RBNZ’s Monetary Policy Committee (MPC) sets the level of the OCR to fulfill these objectives. When inflation rises above target, the MPC may increase the OCR, raising borrowing costs for households and businesses and slowing economic activity. Higher interest rates generally support the New Zealand Dollar by boosting yields and making New Zealand assets more attractive to investors. Conversely, lower policy rates typically weigh on the NZD.

Employment and Inflation Dynamics

Employment plays a central role in the RBNZ’s framework because labor market tightness can contribute to inflationary pressure. The bank defines “maximum sustainable employment” as the highest level of labor utilization that can be maintained over time without triggering accelerating inflation.

According to the RBNZ, “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,” the bank says.

Quantitative Easing as an Extraordinary Tool

In exceptional circumstances, the RBNZ can deploy Quantitative Easing (QE) as an additional policy instrument. Under QE, the central bank creates local currency and uses it to purchase assets, typically government or corporate bonds, from banks and other financial institutions. This process expands the domestic money supply and aims to stimulate economic activity.

QE usually puts downward pressure on the New Zealand Dollar, as the increase in money supply tends to weaken the currency. It is considered a last-resort measure when conventional interest rate cuts are unlikely to be sufficient. The RBNZ implemented QE during the Covid-19 pandemic.