Inflation in New Zealand rose by 2.7% in the second quarter, slightly below the expected 2.8%. The smaller increase was partly due to rents not rising as much as anticipated. The inflation rate for the last three months was 0.54%, down from 0.93% in the previous quarter. This brings it back within the central bank’s target range after a higher rate earlier in the year.

High Service Inflation

Service inflation remains elevated, above 1% from the previous quarter, and is accelerating. However, lower prices for goods provide some relief amid a weak economic outlook. The Reserve Bank of New Zealand may act cautiously, even with the lower inflation figure suggesting a possible interest rate cut in August. This cut might be the last in the current cycle. The drop in inflation supports the case for an interest rate cut by the Reserve Bank. Current derivatives markets suggest there’s over an 85% chance of a 25 basis point reduction in August, which aligns with the data showing inflation is back within target levels. Yet, we need to tread carefully because service inflation remains tough. Official data shows domestic non-tradable inflation stubbornly high at 4.7% annually. This pressure indicates that the central bank should not be overly aggressive in easing policies.

Trading Strategies Amid Inflation Data

With this outlook, we are considering trades that benefit from a single rate cut, but not from a full easing cycle. One strategy is to use interest rate swaps, where we receive a fixed rate on the short end of the curve while paying a fixed rate on the long end. This position profits if near-term rates drop, but long-term expectations remain stable. The speculation that this might be the last cut in the cycle is important, as it differs from past trends. Recent easing cycles since 2000 often included multiple cuts averaging over 150 basis points. The current economic weakness, along with persistent price pressures, presents a unique challenge not seen before. This complex situation also opens up opportunities in currency derivatives. While a rate cut would normally weaken the New Zealand dollar, hinting at it being the final cut might strengthen the currency. We think buying options to capture volatility could be a smart way to trade the expected short-lived market reaction. Create your live VT Markets account and start trading now.

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