06:56 AM EDT, 08/14/2024 (MT Newswires) -- The New Zealand dollar (NZD) has weakened even more than the US dollar (USD), dropping by about 1% overnight against the Australian dollar (AUD) and the US dollar, said Mitsubishi UFG.

It has resulted in the NZD/USD rate falling back towards 0.6000 and the AUD/NZD rising back above 1.1000, wrote the bank in a note to clients. The New Zealand dollar has underperformed after the Reserve Bank of New Zealand's (RBNZ) dovish policy update.

The RBNZ started an easing cycle much earlier than it had previously indicated by cutting rates for the first time overnight by 25bps to 5.25%, stated MUFG. The RBNZ had previously indicated that it wasn't planning to begin cutting rates until the H2 of next year.

That was a view that financial market participants never took too seriously in light of slowing inflation and weak growth in New Zealand alongside restrictive policy rates, pointed out the bank. The RBNZ's decision to begin cutting rates overnight Tuesday reflected its increased confidence that consumer price inflation is returning to within the Monetary Policy Committee's (MPC) 1.0%-3.0% target band.

The RBNZ also expects New Zealand's economy to contract again in Q2 and Q3 which would be the third period of "technical" recession since the end of 2022. The RBNZ noted that the weakness in domestic economic activity is becoming more pronounced.

The updated forward guidance signaled that the pace of further easing will depend on the MPC's confidence that pricing behavior remains consistent with a low inflation environment and that inflation expectations are anchored around the 2% target.

The RBNZ's updated forecasts show that the policy rate is expected to end this year around 4.92% and fall further to around 4.36% by the middle of next year and 3.85% by the end of next year.

Overall, the big dovish policy shift from the RBNZ overnight supports MUFG's short NZD trade idea. The RBNZ may still need to cut rates even more quickly/deeply than indicated by the updated forecasts, added the bank.