NZD/USD price prediction ahead of the RBNZ May meeting

This week, the only central bank to release its monetary policy is the Bank of New Zealand (RBNZ). Traders expect the central bank to raise the Official Cash Rate (OCR) again after lifting it to 1.5% at the last meeting.

Moreover, traders expect more than 25bp. The forecast is that the RBNZ will hike the OCR by 50bp, just like the Fed in the United States did at its last meeting.

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With this rate hike, the RBNZ will bring the OCR to 2% – an elevated level if we compare it with where the interest rates are in other parts of the world. For instance, in the United States, the discount rate is 1%, while in the Eurozone, the deposit facility rate is still negative, at -0.5%.

Yet, the RBNZ wants to do more. Considering the real rate and how high inflation runs in the country, the RBNZ will not hesitate to hike again.

Inflation in New Zealand exceeds RBNZ’s target

Inflation has reached 6.9% in New Zealand, well above the RBNZ’s target. The RBNZ is an operational independent central bank in the sense that it is free to develop monetary policy to achieve its target.

Furthermore, the RBNZ is also target independent because it sets its own inflation target. In New Zealand, the inflation target as set by the RBNZ is a range between 1 and 3 percent on average over the medium term.

But if we adjust the current interest rate of 1.5% with the 6.9% annual inflation rate, the real rate is well below negative. Even if the RBNZ hikes to 2%, as expected, the central bank will be forced to tighten the monetary policy further unless the inflation rate comes down.

So, where does this leave the local currency, the New Zealand dollar?

NZD/USD has been in a downtrend for more than one year

For more than one year, the NZD/USD exchange rate has been in a downtrend. It reached as high as 0.74 at the start of 2021, but it has corrected ever since.

Despite the RBNZ setting a higher interest rate than the Fed, the exchange rate did not recover. Just the opposite – it made a new lower low in 2022.

But a close look at what happened during the COVID-19 pandemic reveals a possible impulsive wave that ended at the 2021 highs. After a five-wave structure like the one shown above, the market typically corrects into the 50%-61.8% area before bouncing.

As such, on a move above 0.66, the NZD/USD bulls would likely add on the long side. If the RBNZ hikes by half a percentage point and the Fed does the same, the interest rate differential would still favor the RBNZ and the New Zealand dollar.