- NZD an outperformer as market looks ahead to RBNZ

- Bets on rate rises firming after inflation seen returning

- RBNZ survey, guidance on rate outlook now key for NZD

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GBP/NZD reference rates at publication:Spot: 1.9657Bank transfers (indicative guide): 1.8970-1.9100Money transfer specialist rates (indicative): 1.9480-1.9520More information on securing specialist rates, hereSet up an exchange rate alert, hereThe New Zealand Dollar was an outperformer in the mid-week session but the key to the Kiwi currency outlook is likely in the detail of Thursday’s inflation expectations survey from the Reserve Bank of New Zealand (RBNZ) and the bank’s guidance next week about future interest rate decisions.

New Zealand’s Dollar advanced against all major counterparts within the G10 contingent of major currencies on Wednesday and was also one of the top performers for the recent week as well as month while occupying the fourth spot among the above referenced group of currencies for 2021 also.

The Kiwi’s burgeoning outperformance is the culmination of a months-long period of anticipation and comes ahead of next Wednesday’s interest rate decision from the RBNZ, which is now widely expected to result in an increase of the official cash rate from 0.25% to 0.5%.

"The Kiwi is a currency to watch. Forward implied yields continue to rise and the differential between both bond and swap rates (and those in Australia) have climbed to multi-year highs," says Martin Whetton, head of fixed income and currency strategy at Commonwealth Bank of Australia.

"To be sure, the RBNZ is only a week away from a first expected rate hike, one of three forecast this year by our ASB colleagues," Whetton adds.

Above: GBP/NZD shown at daily intervals alongside AUD/NZD and NZD/USD.

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Expectations of lift-off for Kiwi interest rates have built in recent months owing to a stronger-than-expected return of inflation, which has been driven by a first-quarter economic performance that was also more robust than many had anticipated as well as other more temporary factors.

“With lockdowns in Australia it was surprising to see the RBA’s tapering plan remain on track, a hawkish surprise indeed. But the better trade in our opinion is long NZD positions in view of the lower COVID-19 risk in the short term and the RBNZ’s hiking cycle soon to start,” says Jordan Rochester, a strategist at Nomura, who’s recently advocated that clients of the bank bet on lower AUD/NZD and EUR/NZD rates.

Recent economic data has seen prices in the overnight-index-swap market for interest rate derivatives - popular tools used by companies and investors to insure themselves against or to wager on interest rate changes - implying that the RBNZ’s cash rate is likely to sit at 0.93% by year-end.

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{wbamp-hide end}{wbamp-show start}{wbamp-show end}That’s tantamount to investors taking to the bank an expectation of nearly three 0.25% rate rises before the curtain closes on 2021, although the same market also implied this Wednesday that at least one further rate rise is likely before the end of 2022, with the cash rate seen at 1.37% by then.

These expectations are a recipe for New Zealand Dollar losses if it transpires next Wednesday that the RBNZ is likely to be more cautious and slower in raising its interest rate, although they’re also a potential catalyst for further gains if the bank affirms the market’s view of the outlook as on the money.

Clues as to which way next Wednesday’s decision is likely to be cut could be found in the results of the latest inflation expectations survey carried out by the RBNZ itself, which are set for release around 04:00 in the early hours of London’s Thursday morning this week.

Above: ANZ Business Outlook survey results show inflation expectations and corporate pricing intentions.

"The ANZ survey of businesses shows that a record number of businesses are willing to pass their higher costs (labour and capital) onto consumers. So, a strong reading in the 2Y inflation expectations of corporates in the RBNZ survey would be another clear signal that the RBNZ has to begin withdrawing stimulus," says David Forrester, a strategist at Credit Agricole CIB.

It’s inflation which the RBNZ is seeking to manage when it makes changes to its policy settings, in the context of a 1%-to-3% target band, although inflation is influenced by many factors including momentum in the economy as well as ‘supply side’ factors like the availability of goods and services.

Generally it’s the expected level of inflation some two-years ahead which has the most influence over central bank monetary policy decisions and last time around the RBNZ’s survey showed Kiwi companies anticipating an inflation rate of around 2.05% on average in two years time, which was slightly above the midpoint of the RBNZ’s target band already.

Any further increase in inflation expectations might be likely to fuel further the already elevated expectations of the RBNZ and could potentially serve to keep the New Zealand Dollar on its front foot against other currencies into the weekend.