Is it better to cut rates sooner rather than later for the New Zealand Fed?

New Zealand's second-quarter employment data beat expectations, leading to a reassessment of rate cut expectations and a subsequent bullish move in the NZDUSD. The likelihood of a rate cut has since increased, with market pricing suggesting that the New Zealand Federal Reserve will cut rates by 25 basis points this month. Market pricing also suggests two more similar rate cuts before the end of the year.

On the other hand, analysts believe rates will stabilize at 5.5% and they may be correct as inflation has not yet consistently reached the NZ Fed's target of 1-3% and remains significantly above the 2.0% target. Non-trade inflation, which includes housing and construction costs, has barely slowed and remains high at 5.4 percent.

However, a rate cut this month may be justified, or at least it may be earlier rather than later. A survey conducted by the central bank showed a significant drop in inflation expectations from 1 to 10 years, with 2-year inflation expectations, which are closely monitored by the Reserve Bank of New Zealand, converging on the 2.0 percent target from 2.33 percent previously. Public opinion is also optimistic that the battle against inflation has been won.

Macroeconomic data raises the likelihood of a rate cut

In addition, quarterly GDP figures returned to growth in the three months to March, albeit at a rate of just 0.2 percent, which is below the pre-epidemic level. Disappointingly, the manufacturing sector took its biggest hit since 2021 in July, according to PMI data, and the latest figures for the services sector were also disappointing.

In terms of the labor market, unemployment trended upward for the fifth consecutive quarter, rising to its highest level in three years, despite surprisingly upbeat data for the second quarter. In addition, despite surprising quarterly wage growth, the annual rate fell to a two-year low of 3.6 percent, while hours worked fell by 1.2 percent on a year-on-year basis. By mid-2025, the New Zealand Federal Reserve expects the unemployment rate to continue to rise to 5.1 percent.

Market reaction

The next updates to inflation and employment data are due in October and November, respectively, leaving some to wonder whether the New Zealand Fed will be patient enough to wait until the end of the year to ease policy as talk in the US of a bold 50 basis point rate cut in September heats up. One possible initial move by policymakers could be to revise the phrase “higher rates for longer” they used in their May statement or to bring forward the timetable for rate cuts to 2024 from March 2025, as previously forecast.

If rates remain stable, or a 25 basis point cut, coupled with a more aggressive rate cut signaled at the upcoming meeting, this could put pressure on the NZDUSD, which could push the pair towards 0.5900 if the 20-day Simple Moving Average (SMA) proves to be fragile. or even lower, with the door open for a double-bottom area at 0.5850.

In the opposite scenario, where the New Zealand Fed maintains a tough tone and leaves rates unchanged for the time being due to sticky non-trade inflation, with a lower-than-investor-expected rate cut before the end of the year, then the pair could rise, re-challenging the 50- and 200-day moving averages in the 0.6060-6080 area. Even higher, bulls could challenge the key resistance zone of 0.6147-0.6173.

Notably, U.S. CPI and retail sales data are also on the agenda this week, which could heighten market volatility.