New Zealand Dollar hits fresh three-month highs as central banks divergence hurts the Aussie

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The New Zealand Dollar (NZD) extended gains against the Aussie Dollar (AUD) on Tuesday.

AUD/NZD extends losses below 1.2000 and hits three-and-a-half-month lows at 1.1955.
RBNZ-RBA monetary policy divergence has been crushing the Aussie over the last five days.
RBNZ Chief Economist, Paul Conway, reiterated on Monday that the bank might have to do more to tackle inflationary risks.

The New Zealand Dollar (NZD) extended gains against the Aussie Dollar (AUD) on Tuesday. The AUD/NZD pair has plunged more than 2% over the last five trading days, reaching three-and-a-half-month lows at 1.1955, weighed by the divergent monetary policy stances of the New Zealand and the Australian central banks.

The Reserve Bank of New Zealand (RBNZ) hiked its Official Cash Rate (OCR) by 25 basis points to 2.50% last week and hinted at further monetary tightening in the coming months. In the press release following the decision, RBNZ Governor Anna Breman reckoned that monetary policy is still at accommodative levels, while concerns about second-round effects on inflation remain high.

These views were endorsed on Monday by comments from RBNZ Chief Economist Paul Conway, who said that the bank will have to “act more firmly to re-anchor inflation expectations”, to tackle the risks of temporary shocks becoming persistent inflation.

The Reserve Bank of Australia (RBA), on the other hand, left interest rates on hold at 4.35% in June and hinted at a pause period to assess the impact of the three rate hikes delivered earlier this year.

The resumption of hostilities between the US and Iran this week and the ensuing rally in Oil prices have raised speculation about a fourth rate hike by the RBA before the end of the year. The soft Australian Consumer Price Index (CPI) figures seen last week, however, cooled expectations of any immediate tightening move, and put additional pressure on the Aussie.

Central banks FAQs

What does a central bank do?

Central Banks have a key mandate which is making sure that there is price stability in a country or region. Economies are constantly facing inflation or deflation when prices for certain goods and services are fluctuating. Constant rising prices for the same goods means inflation, constant lowered prices for the same goods means deflation. It is the task of the central bank to keep the demand in line by tweaking its policy rate. For the biggest central banks like the US Federal Reserve (Fed), the European Central Bank (ECB) or the Bank of England (BoE), the mandate is to keep inflation close to 2%.

What does a central bank do when inflation undershoots or overshoots its projected target?

A central bank has one important tool at its disposal to get inflation higher or lower, and that is by tweaking its benchmark policy rate, commonly known as interest rate. On pre-communicated moments, the central bank will issue a statement with its policy rate and provide additional reasoning on why it is either remaining or changing (cutting or hiking) it. Local banks will adjust their savings and lending rates accordingly, which in turn will make it either harder or easier for people to earn on their savings or for companies to take out loans and make investments in their businesses. When the central bank hikes interest rates substantially, this is called monetary tightening. When it is cutting its benchmark rate, it is called monetary easing.

Who decides on monetary policy and interest rates?

A central bank is often politically independent. Members of the central bank policy board are passing through a series of panels and hearings before being appointed to a policy board seat. Each member in that board often has a certain conviction on how the central bank should control inflation and the subsequent monetary policy. Members that want a very loose monetary policy, with low rates and cheap lending, to boost the economy substantially while being content to see inflation slightly above 2%, are called ‘doves’. Members that rather want to see higher rates to reward savings and want to keep a lit on inflation at all time are called ‘hawks’ and will not rest until inflation is at or just below 2%.

Is there a president or head of a central bank?

Normally, there is a chairman or president who leads each meeting, needs to create a consensus between the hawks or doves and has his or her final say when it would come down to a vote split to avoid a 50-50 tie on whether the current policy should be adjusted. The chairman will deliver speeches which often can be followed live, where the current monetary stance and outlook is being communicated. A central bank will try to push forward its monetary policy without triggering violent swings in rates, equities, or its currency. All members of the central bank will channel their stance toward the markets in advance of a policy meeting event. A few days before a policy meeting takes place until the new policy has been communicated, members are forbidden to talk publicly. This is called the blackout period.