MUFG forecasts RBNZ to hike to 3% but fall short of hawkish path, flags NZD risk

According to MUFG, the risk is tilted toward the New Zealand dollar. Since a rate hike is already almost fully priced in, the currency's recent outperformance among G10 peers depends on the RBNZ endorsing a much steeper path than MUFG anticipates. If the central bank uses neutral or wait-and-see language, it could trigger a repricing of the roughly 3.5 additional hikes priced, pulling front-end yields lower and pressuring the kiwi. AUD/NZD would likely benefit ahead of the RBA meeting on November 2-3. A hawkish surprise would only delay that repricing, not prevent it, in MUFG's view. Oil remains the main counterweight: further gains in crude would boost New Zealand's fuel-driven inflation and make the market's more aggressive path harder to unwind.

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Previously:

• All 5 major NZ banks expect RBNZ to hike to 3% today, but split on how far rates will go
• Preview: RBNZ set to lift OCR to 3% ahead of election as oil and weak kiwi fuel inflation
• NZIER Shadow Board majority backs 25bp RBNZ hike to 3% as oil and weaker kiwi bite

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MUFG expects the RBNZ to raise rates today but then disappoint, contending that New Zealand's spare capacity does not support the rate trajectory markets have priced. This means the kiwi's recent gains are temporary.

Summary:

• MUFG forecasts a 25bp increase in the OCR to 3% at 01:00 GMT (21:00 US Eastern Tuesday), with the move nearly fully priced in.
• The bank anticipates just one additional rise, to a peak of 3.25%, whereas markets anticipate about 3.5 further increases after today.
• According to MUFG, modestly softer Q3 inflation indicates spare capacity, and the jobless rate climbed to 5.6% in Q2, the highest since Q3 2015.
• This month, the NZ dollar ranks third among G10 currencies for performance. MUFG says sustaining that requires a hawkish hike and robust guidance.
• MUFG sees downside risks for the NZ dollar and forecasts it to underperform over its outlook period.

In a preview, MUFG predicts the RBNZ to lift the official cash rate by 25bp today but stop short of the aggressive path markets anticipate, leaving the NZ dollar vulnerable to downside.

The decision is scheduled for 01:00 GMT Wednesday (21:00 US Eastern Tuesday). MUFG noted the rates market is nearly fully pricing a 25bp hike that would bring the OCR to 3%, the third straight increase. The bank expects the RBNZ to deliver this, but forecasts only one more rise afterward, to a peak of 3.25%. In MUFG's estimation, current pricing implies roughly 3.5 additional hikes after today, with three total by March.

This divergence matters for the NZD. MUFG flagged that the kiwi has been the third-best G10 performer in October, a streak reliant on the RBNZ providing a hawkish hike and guidance that confirms current pricing. Without it, the support from rate expectations may diminish.

MUFG's argument for a less steep path is based on the domestic economy. The bank said Q3 inflation was slightly below expectations, which it attributes to spare capacity in New Zealand's economy. It also cited the rise in unemployment to 5.6% in Q2, the highest since Q3 2015. MUFG believes that slack means the economy does not need as much tightening as markets currently price.

The bank stated that NZD risks are tilted downward. Even with a hawkish hike today, MUFG anticipates investors will eventually question the number of hikes priced, and it projects the currency to lag over its forecast period.

MUFG's outlook places it at the dovish end of the spectrum. Among local banks, ANZ expects a pause in December, while ASB and Westpac forecast the OCR reaching 3.5% by February. Since today's meeting is a Monetary Policy Review without updated forecasts or a rate track, the tone of the RBNZ's statement will likely determine which scenario markets favor.