GBP & NZD Outperform

May 22, 2024

GBP & NZD Outperform

  • GBP rallies on a lower-than-expected drop in UK inflation.
  • RBNZ unexpectedly delivered a hawkish hold, supercharging NZD.
  • The FOMC May meeting minutes is expected to highlight the higher-for-longer policy rate environment.

USD remains supported as Fed policymakers continue to urge patience before easing. Yesterday, Fed Governor Christopher Waller said “in the absence of a significant weakening in the labor market, I need to see several more months of good inflation data before I would be comfortable supporting an easing in the stance of monetary policy”. Waller’s comments were echoed overnight by Cleveland Fed President Loretta Mester (voter) and Atlanta Fed President Raphael Bostic (voter).

The FOMC May meeting minutes is expected to highlight the higher-for-longer policy rate environment (7:00pm London). At that meeting, the Fed kept rates steady while acknowledging the worsening inflation outlook by adding that “In recent months, there has been a lack of further progress toward the Committee's 2% inflation objective.” In his post-meeting press conference, Fed Chair Jay Powell pushed back against rate hike expectations and highlighted paths that would cause the Fed to want to consider rate cuts. As such, the minutes will be key to seeing whether there was any underlying dissent with Powell’s more cautious tone.

NZD outperformed and New Zealand bonds underperformed after the RBNZ delivered a hawkish hold. We anticipated a dovish hold and we’re caught flat-footed. The RBNZ left the Official Cash Rate (OCR) at 5.50% as widely expected. However, “the Committee discussed the possibility of increasing the OCR at this meeting” and “agreed that interest rates may have to remain at a restrictive level for longer than anticipated in the February Monetary Policy Statement”.

Indeed, the updated projections have the OCR peaking at 5.65% in Q4 2024 vs. 5.60% in Q3 2024 previously, and a first OCR cut is pencilled-in for Q3 2025 vs. H1 2025 previously. The higher outlook for the OCR reflects the more gradual decline in inflation towards 2%. Of note, the RBNZ revised up its estimate of the nominal long-run neutral interest rate to 2.75% from 2.50% suggesting policy may be less restrictive than previously assumed.

The RBNZ post-meeting press conference generated some volatility. RBNZ Governor Adrian Orr said raising the OCR today had been a “real consideration”. However, Chief Economist Paul Conway downplayed the risk of a rate hike by December warning that interpreting the OCR track forecasts is “spurious”.

Regardless, NZD/USD pared back most of its post RBNZ meeting gains as the swaps market continues to position for RBNZ rate cuts this year. 34bps of OCR cuts is currently priced-in for 2024 vs. 44bps yesterday. A rate cut by year-end is about right in our view.

GBP/USD rallied to near a two-month high around 1.2760 on a lower-than-expected drop in UK inflation. UK headline inflation plunged to 2.3% y/y in April (consensus: 2.1%, BOE projection: 2.1%)) from 3.2% y/y in March reflecting energy-related base effects and a fall in the Ofgem energy price cap. Core inflation slowed to 3.9% y/y (lowest since October 2021) vs. 4.2% y/y in March. Services inflation eased only a tick to 5.9% y/y (consensus: 5.4%, BOE projection: 5.5%).

Overall, UK services inflation remains high and suggests the BOE can wait before cutting the policy rate. Moreover, the BOE will look through regulated energy price base effects and wait for clearer signs of persistent disinflation before easing. The swaps market slashed odds of a June and August rate cut. A first full rate cut is priced-in for September/November. The upward adjustment to UK interest rate expectations supports a firmer GBP particularly versus EUR.

EUR/USD is directionless around 1.0860. ECB President Christine Lagarde pointed out again “there is a strong likelihood” of a rate cut in June. But ECB Governing Council member Joachim Nagel tempered expectations of additional policy rate cuts beyond June warning “we should not cut rates hastily and jeopardize what we have achieved.”

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