AUD and NZD: Persistently low underlying inflation likely to spur a July RBNZ rate cut

New Zealand's Q2 CPI is due next week and should show a sharp rebound on the back of higher petrol prices. More important will be the measures of underlying inflation, which averaged around 1% in Q1. This is well below the 2% inflation target and is the largest undershoot on record. A 25bp cut is expected in June and a follow-up cut in July, but a weaker economic outlook clearly increases the risk that the RBNZ will cut further, such that it could reverse all of last year's four rate rises. 

Strong house prices would ordinarily stand in the way of further rate cuts, but tougher macro-prudential policy and new tax measures, both aimed at cooling the Auckland market, give the RBNZ with room to move. More interesting is the falling NZD, where the TWI has fallen from a recent peak of 80 to 70 - the lowest level since 2012. The RBNZ would be very pleased to see the drop in the exchange rate, but would be hoping for further weakness to help cushion the impact of much lower dairy prices. The lower currency is not an impediment to further rate cuts, particularly given the increased uncertainty around the outlook for China. 

"We remain bearish NZD. We see AUD trading heavy, taking direction from Chinese activity data and stock market performance," siad Barclays in a report on Monday.