Kiwis Still on the Menu?

[Update Added Below x 2]

Well, it could certainly seem so after today's inflation figures which beat the central bank's expectations. It is of course still too early to say anything but with today's inflation data the markets are gearing up for the RBNZ to raise the refi rate to an unprecedented 8.25% next week. In doing so the bank will clearly be playing into the hands of all those savvy retail investors and indeed institutional players playing the carry trade which is driven by very high global capital mobility and high interest rate differentials between central banks.

Here is a quick summarizing quote from the FT ... (linked above)

Non-tradable, or domestic, inflation - which excludes import prices - rose 1.1 per cent on the previous quarter and 4.1 per cent on year. That compares with 1.2 per cent on quarter and 4.1 per cent on year in the first quarter. New Zealand’s interest rates are already at 8 per cent, the highest in the industrialised world, fuelling a rise in the New Zealand dollar driven by yield-hungry investors. Economists now believe the bank will probably need to raise interest rates to a new record of 8.25 per cent next week in order to stem the rise in inflation. ”It’s very strong and strong in all the wrong places from the (Reserve Bank’s) point of view,” Nick Tuffley, chief economist at the ASB Bank in Auckland, told local media. ”This has raised the odds of an interest rate increase,” he said.

Eight of 14 analysts surveyed by Bloomberg expect the official cash rate to be raised by a quarter percentage point on July 26. Strong appetite for carry trades, in which low-yielding currencies are sold to fund the purchase of higher yielding currencies, has driven the kiwi dollar to record levels. The Reserve Bank of New Zealand in June took the unprecedented step of intervening in the currency market to try to stem a rally that had seen the kiwi dollar rise to its highest level since being floated in 1985.

As you may remember and as the FT also notes it was not too long ago that the RBNZ actually intervened in the FX market in order to halt the appreciation of the currency. From a text book perspective this is probably making many an econ 1-0-1 student (or perhaps their professors?) a wee bit weary about what the textbook tells them since a central bank presiding over a rather large and growing current account deficit shouldn't exactly be in the market to depreciate its currency, now should it? Well, this is the nature of the current interest differential yield game being played world wide and as we can see it is already becoming something of a test of minds between market participants and policy makers in the central banks. If the inflows themselves are what is, in part, fuelling the inflation then of course raising rates might not do trick, on the contrary (are you listening in Frankfurt?). My guess is that it would be a good idea to keep a weather eye on those high yielding currencies and their respective central banks; especially if the ECB stops its hiking campaign sometime in the latter part of 2007 those CBs still having the courage to look north will be in for a turret ride I think.