The New Zealand dollar rose against its Australian counterpart after Australia posted its weakest inflation in seven years, sparking speculation of an interest hike across the Tasman just as the market is preparing for the local Reserve Bank's rate decision.

The kiwi rose to 90.12 Australian cents as at 5pm in Wellington from 88.90 cents before the inflation figures were released and from 89.16 cents late yesterday. The local currency rose to 68.81 US cents from 68.57 cents yesterday.

Australia's consumer price index fell 0.2 per cent in the first quarter, the biggest quarterly decline since December 2008, for an annual gain of 1.3 per cent, undershooting market forecasts and raising the possibility that the Reserve Bank of Australia will cut its cash rate from 2 per cent next week.

That's an extra wrinkle for bets on the Reserve Bank of New Zealand, which is expected to wait until June to cut instead of moving tomorrow when its review is due three hours after the Federal Reserve's latest statement.


"That would add fuel to the fire for the RBNZ tomorrow," said Mark Johnson, senior dealer at OMF. "What the Reserve Bank has got to figure out is what's the point of waiting. The risk to inflation expectations if they procrastinate would do more harm than good.

"The market has officially priced in just a 35 per cent chance of a cut to the official cash rate tomorrow while the chances of a cut at the full monetary policy statement on June 10 are put at 86 per cent.

Johnson said governor Graeme Wheeler may get more impact by cutting tomorrow. A good outcome for Wheeler would be a relatively hawkish statement from Fed chair Janet Yellen and a cut to the OCR tomorrow, which would give the kiwi dollar some "good downward momentum" and may help revive inflation in the tradables sector.

Wheeler is hoping over time to encourage annual inflation back into the bank's 1 per cent-to-3 per cent band, which it has been below since the third quarter of 2014. Based on the bank's March projections, inflation will accelerate to 1.1 per cent in calendar 2016.

The trade-weighted index rose to 72.67 from 72.59 late yesterday.The kiwi fell to 47.16 British pence from 47.41 British pence yesterday and dropped to 60.83 euro cents from 61.04 cents. The local currency was little changed at 76.37 yen and slipped to 4.4628 yuan from 4.4656 yuan.

The two-year swap rate was unchanged at 2.20 per cent and the 10-year swaps were steady at 2.99 per cent.