RBNZ expected to cut interest rate by 50 bps amid declining inflation and slowing economic activity

• The Reserve Bank of New Zealand is expected to cut interest rates by 50 bps to 4.75% on Wednesday.
• New Zealand's deepening economic downturn and inflation optimism flag outsized RBNZ rate cut bets.
• The RBNZ policy announcements are set to inject intense volatility into the New Zealand Dollar.

The Reserve Bank of New Zealand (RBNZ) is set to follow the US Federal Reserve's (Fed) footsteps when it announces its interest rate decision on Wednesday at 01:00 GMT.

New Zealand's central bank will not publish the quarterly economic projections alongside its policy statement. There will be no press conference from Governor Adrian Orr to follow.

What to expect from the RBNZ interest rate decision?       

The RBNZ is widely expected to lower the Official Cash Rate (OCR) by 50 basis points (bps) from 5.25% to 4.75% following its October monetary policy meeting. The central bank delivered a surprise 25 bps rate cut back in August.

Since then there has been no piece of new macro news, except for New Zealand's June quarter Gross Domestic Product (GDP) report. Data released by Statistics New Zealand on September 19 showed that GDP declined 0.2% in Q2 from the previous quarter's revised 0.1% growth. Economists expected a 0.4% contraction in the reported period, while the RBNZ projected a 0.5% drop.

Despite a smaller-than-expected GDP contraction in Q2, the declining trend in inflation and slowing economic activity help build a case around a potential 50 bps cut by the RBNZ this week. However, New Zealand's sticky non-tradable inflation and a strong resurgence in business confidence could lead the RBNZ to opt for a smaller rate reduction in November.

"The RBNZ's latest projections have headline CPI at 2.3% and non-tradeable CPI at 5.1% in the third quarter," FX Strategists at ING noted. 

"We see a non-negligible risk of inflation having dropped below the 2% target range mid-point, but non-tradable CPI should continue to be stickier. Accordingly, this 50bp cut may be a one-off move, with the RBNZ defaulting back to 25bp gradual reductions into a terminal rate close to 3%, they added. 

How will the RBNZ interest decision impact the New Zealand Dollar?

The New Zealand Dollar (NZD) is hanging close to its lowest level in a month against the US Dollar (USD), near 0.6100, as markets fully price in a 50 bps RBNZ rate cut on Wednesday. Meanwhile, the USD stands tall across the board as the strong September Nonfarm Payrolls (NFP) data prompted markets to rule out an outsized Fed rate cut in November.

Heading into the RBNZ policy announcements, the NZD/USD pair appears to be at a two-way risk, as its fate hinges on the central bank's communication on the size and the pace of the future rate cuts.

If the central bank lowers OCR by the expected 50 bps but surprises with a cautious tone in its policy statement, pushing back against expectations of more outsized rate cuts, the NZD is likely to find fresh demand. In such a case, NZD/USD could stage a strong comeback toward the 0.6300 level. A surprise 25 bps rate cut by the RBNZ could also revive NZD buyers.

On the other hand, NZD/USD could see a renewed downtrend toward 0.6000 should the RBNZ acknowledge the progress in disinflation while voicing concerns over the economic pain, leaving the door open for more large rate cuts.

Dhwani Mehta, FXStreet's Senior Analyst, offers a brief technical outlook for trading the New Zealand Dollar on the RBNZ policy announcements: "The NZD/USD pair is challenging the critical 200-day Simple Moving Average (SMA) at 0.6099, as the 14-day Relative Strength Index (RSI) remains deep in the bearish territory."

"If buyers manage to defend the key 200-day SMA, a recovery could initiate toward the 21-day SMA at 0.6226. Ahead of that, the 50-day SMA at 0.6157 could come into play. Alternatively, a sustained break below the 200-day SMA could fuel a fresh downtrend toward the 0.6000 level, below which the August 16 low at 0.5978 will be tested," Dhwani adds.