The kiwi dollar shed about half a US cent and swap rates fell after the Reserve Bank added a modest increase to its forecast track for interest rates, prompting traders to drop bets for a rate hike as soon as this year.
The kiwi dollar dropped to 72.57 US cents from 73.02 cents immediately before the RBNZ statement and the trade-weighted index fell to 79.03 from 79.49. The two-year swap rate fell 5 basis points to 2.30 per cent.
The central bank revised up its track for the official cash rate, which flat-lined in the November monetary policy statement, to reflect 25 basis points of increase by March 2020. Governor Graeme Wheeler repeated his November comment that there were "numerous uncertainties" in the outlook and said monetary policy will remain accommodative "for a considerable period". Traders trimmed their bets for an early hike, with the Overnight Interest Swap market putting less than 50 per cent odds of a hike at the November meeting this year, having previously had such a hike fully priced in.
"The base case is rates on hold for a long time and when the time comes, they are more likely to go up than down," said Robin Clements, senior economist at UBS New Zealand. "It's a moot point whether having some hikes in 2020 is just a symbol, a token gesture if you like."
Clements said he expects interest rate hikes from about mid-2018 and didn't see the need to change that following today's MPS.
Wheeler repeated his concerns about the kiwi dollar being too high, saying the exchange rate "remains higher than is sustainable for balanced growth and, together with low global inflation, continues to generate negative inflation in the tradables sector". Even so, he said long-term inflation expectations "remain well anchored at around 2 percent", the midpoint of the bank's target range. Annual inflation was 1.3 per cent in the fourth quarter, the first time in more than two years that it has been within the target band.
The Reserve Bank trimmed its track for inflation, with a return to 2 per cent on an annual basis not expected until mid-2019. The bank projects inflation to be about 1.5 per cent through most of this year, softening to 1.3 per cent at the start of 2018 before creeping up to 2 per cent by the middle of 2019, later than what was projected in the November forecast.
"That certainly looks a long way off given what we see across the domestic economy, though it is obviously a hat-tip to the important inflation-suppressing impact that the strong NZD is having," ANZ Bank New Zealand economists Cameron Bagrie and Philip Borkin said in a note. "It is a clear reminder that the NZD is still a highly important input into the RBNZ's monetary policy deliberations."
Since the RBNZ cut the OCR a quarter-point to a record low 1.75 per cent in November, the US Federal Reserve has projected a more aggressive round of rate hikes might be needed in the world's biggest economy where robust growth will be stimulated by an expansionary infrastructure programme from President Donald Trump. That's lifted bond yields around the world and was part of the reason some traders had started pricing in rate hikes in New Zealand as early as this year.