Dollar drops 2% in 2 hours on more upbeat Fed, cautious RBNZ

NZ dollar drops 2% in 2 hours on more upbeat Fed, cautious Reserve Bank.

The New Zealand dollar dropped about 2 percent in just two hours this morning after the Federal Reserve gave a more upbeat than expected assessment of the US economy and New Zealand's Reserve Bank gave no signal it would need to raise interest rates.

The kiwi tumbled after each central bank event, to touch a low of 77.66 US cents. It recently traded at 77.95 US cents, from 78.13 cents before the RBNZ's 9am statement and 79.37 cents ahead of the Fed's 7am statement.

The New Zealand dollar dropped as the greenback strengthened against most major currencies after the Fed confirmed it would end its stimulatory asset purchase programme and cited strength in the labour market, one of its key measures of an improving economy. The kiwi was further hit after Reserve Bank governor Graeme Wheeler confirmed the benchmark interest would remain on hold and removed a reference to the need for further tightening to curb inflation, following weaker-than-expected inflation data last week.

"The removal of the explicit tightening bias is more dovish than we had anticipated and certainly more dovish than the market had anticipated," said Bank of New Zealand currency strategist Raiko Shareef. "It really pushes any rate hikes further out and definitely opens the door to the idea that maybe we are at the end of the tightening cycle. The fall in the kiwi is justified."

BNZ's Shareef said the kiwi may drop further should Reserve Bank data scheduled for release this afternoon show Wheeler intervened significantly in the market last month in an attempt to lower the value of the currency.

Reserve Bank figures released last month showed the central bank sold a net $521 million in August, and should today's release show it sold $700 million to $1 billion in September, the kiwi may test 77.10 US cents, Shareef said. The figures are due out at 3pm.

In a one-page statement today, Wheeler kept the official cash rate at 3.5 percent as expected.

"CPI (consumers price index) inflation is currently at a low level despite above-trend growth. However, inflation is expected to increase as the expansion continues," Wheeler said. "A period of assessment remains appropriate before considering further policy adjustment."

Today's statement removed the bank's previous view that "further tightening will be necessary to keep inflation near the 2 percent target", reinforcing analyst forecasts for a later resumption of rate hikes after four increases between March and July. The bank had already signalled a slower pace of OCR hikes in its September forecast for the 90-day bank bill rate, trimming 50 basis points over the projected horizon.

Government data last week showed inflation slowed to an annual pace of 1 percent in the September quarter, weaker than anticipated and at the bottom of the Reserve Bank's target band of 1 percent to 3 percent. The figures showed cheaper household contents and communication services and equipment offset more expensive housing, and a strong New Zealand dollar continued to limit tradable inflation.

Wheeler said the pace of inflation remains modest, with "subdued wage inflation, well-anchored inflation expectations, weak global inflation, falls in oil prices and the high New Zealand dollar" contributing to low price increases.

"House price inflation has fallen significantly since late 2013, in part due to interest rate increases and the LVR (loan-to-value ratio) restrictions," he said.

Wheeler imposed the limits on low equity home lending last year as a means to try and cool buoyant housing markets in Auckland and Christchurch without having to resort to interest rate hikes for fear of stoking demand for an already high New Zealand dollar.

He reiterated that the local currency is "unjustified and unsustainable" at its current level, and is holding back growth in the tradable sector, while acknowledging falling commodity price and global market volatility had taken some pressure of the kiwi.

"We expect a further significant depreciation," he said.

The local currency has dropped from a peak of 88.35 US cents in July as global demand for the greenback grows on the prospect of the Fed moving away from its stimulatory asset purchase programme of the past five years, and the Reserve Bank has been active in foreign exchange markets to try and encourage its decline. The Fed today wound up its quantitative easing programme, and said it will probably keep the federal funds rate near zero for a considerable time, to assess the strength of the US economic recovery.

The RBNZ's Wheeler said the global economy is growing at a moderate pace, though recent data showed a softening in major economies excluding the US.

New Zealand's economy was growing above trend through 2014, with strong construction activity, high inbound migration and low interest rates supporting the expansion.

"Output growth is expected to moderate over coming years, towards a more sustainable rate," he said.

The ANZ Business Outlook survey yesterday showed firms were more confident in October, snapping seven months of decline, after the uncertainty of the Sept. 20 general election passed with the re-election of the incumbent National-led administration.