New Zealand Dollar weakens as risk aversion overshadows hawkish RBNZ outlook

• The New Zealand Dollar weakens against the US Dollar as renewed risk aversion weighs on market sentiment.
• Stronger-than-expected inflation in New Zealand reinforces expectations of another RBNZ rate hike in September.
• US threats against Iran boost safe-haven demand and support the US Dollar.

NZD/USD trades around 0.5815 on Wednesday at the time of writing, down 0.16% on the day. Despite stronger-than-expected inflation data from New Zealand, the New Zealand Dollar (NZD) remains under pressure as investors favor the US Dollar (USD) amid escalating geopolitical tensions between the United States (US) and Iran.

New Zealand's annual inflation accelerated to 4.1% in the second quarter from 3.1% in the previous quarter. The reading exceeded both market expectations of 4% and the Reserve Bank of New Zealand's (RBNZ) forecast of 3.9%, marking the highest level since the fourth quarter of 2023. The data reinforces recent warnings from RBNZ Chief Economist Paul Conway about persistent inflationary pressures and strengthens expectations that the central bank will deliver another rate hike at its September meeting, following July's increase, its first in three years.

RBNZ tightening expectations underpin Kiwi as inflation risks persist

Strategists at BBH argue that “above target inflation and a more favorable domestic growth outlook” continue to support the case for additional RBNZ rate hikes, which they see as NZD supportive. They note that at its last July 8 meeting, the RBNZ raised the Official Cash Rate (OCR) by 25 bps to 2.50% and indicated that “further OCR increases appear likely at upcoming meetings.” Reflecting this hawkish stance, BBH points out that “the swaps curve price in 60bps hikes by year-end and a total of 100bps of tightening over the next twelve months to 3.50% – near the top of the RBNZ estimated neutral range (2.20%-4.10%).”

According to TD Securities, upside risks to inflation “remain given renewed Middle East tensions pushing Brent above $90,” reinforcing the need for further policy tightening. The bank adds: “We expect the RBNZ to hike again in September, after it restarted its hiking cycle in July.”

However, this supportive monetary policy backdrop for the New Zealand Dollar is being overshadowed by deteriorating market sentiment. Investors are reducing exposure to risk-sensitive currencies as tensions between the United States and Iran continue to escalate. US President Donald Trump warned on Wednesday that the United States would strike Iranian bridges and power plants if Tehran attacks another vessel in the Strait of Hormuz, raising fears of a broader conflict and further disruptions to global energy supplies.

These geopolitical concerns are supporting demand for safe-haven assets, benefiting the US Dollar and limiting the upside potential for NZD/USD despite expectations of further monetary tightening in New Zealand.

Meanwhile, according to the CME FedWatch tool, markets continue to price in a strong chance that the Federal Reserve (Fed) will leave interest rates unchanged at its next meeting while maintaining expectations for tighter monetary policy over the longer term. This outlook is also helping to support the Greenback against more risk-sensitive currencies.