How New Zealand's Central Bank has given up the fight and what their interest rate decision means...

It's the 24th May 2023, 3pm local time. The Reserve Bank of New Zealand (RBNZ) has just increased the official interest rate by 0.25% to 5.50%, as expected. What happened next was not expected... The RBNZ announced that they currently have no intention of raising rates further and that the next rate change could possibly be a cut!

What does the RBNZ's decision mean for New Zealand and the NZD?

Central banks across the globe have been increasing rates over the last 12 months to tackle high inflation. In some countries, like the US, inflation has been coming down and is currently edging toward a 2% norm. For other countries, inflation has been much more stubborn. New Zealand is one of these countries with "sticky" inflation, which is currently sitting just below 7% and hasn't really budged over the last year.

The RBNZ's main weapon to fight inflation is to raise interest rates. Until now, the markets have expected the RBNZ, along with other central banks, to keep raising rates in order to bring inflation down. New Zealand's central bank has announced they are no longer going to do this. So, what does this mean?

Well, it means that high inflation could be a new norm for New Zealanders. The central bank is giving up the fight. High inflation has won. Inflation is here to stay!

This is obviously not good news for the NZD, hence today's strong NZD sell off.

High inflation combined with no more rate hikes, and poor PMI figures, may result in the NZD to continue to weaken longer-time.

Could the NZD continue to sell off?

The outlook doesn't look great for New Zealand, but this is not Brexit or a financial crisis. There are economic figures indicating good economic health for New Zealand, such as strong - relative to other global economies - GDP growth and low unemployment.

The announcement of no more rate hikes could be a bearish driving force for the NZD, though.

What does this mean for the rest of the world?

The Australian Dollar (AUD) is strongly correlated to the NZD, meaning we could see the AUD fall also, which has already started. It wouldn't be a great shock, to see the Reserve Bank of Australia take a similar stance to their neighbours, which could see the AUD fall further.

What could really shift the markets is if the RBNZ have set the tone for the rest of the Western world. Now that the RBNZ have given up, could other central banks do the same? This may result in downside moves for the Euro, British Pound, Rand, and other global currencies.

What could interest rates go from here?

For New Zealand, rates are likely to stay where they are, until a cut is needed. When will a interest rate cut be needed, you ask? Well, likely when the Kiwi economy hits recession, which may not be anytime soon.

How to trade the RBNZ's decision...

The US continues to lead the way for the Western world with regarding to bringing inflation to a 2% norm. Canada is following a similar trend. Singapore is not too far off. Economies such as the Euro Area, the UK, Scandinavia, and South Africa continue to face an issue of stubbornly high inflation. These countries could take a similar approach to the RBNZ but it's way too early to tell. At the moment, rate hikes continue to be on the table for the foreseeable future.

For me, the inflation trades seem obvious, buy the US Dollar and sell the NZD and AUD. If other central banks follow suit to the RBNZ decision, then selling the currencies related to those central banks is an obvious trade, especially the EUR, GBP, ZAR and SEK.