Dollar divergence won’t last

The recent divergence of the Australian and New Zealand dollars has been driven by swings in relative interest rate expectations, but we doubt it will be sustained. (See Chart below.) We think the markets are right to start pricing in rate cuts in New Zealand, which suggests that the recent weakening in the New Zealand dollar against the US dollar will be sustained. However, we believe they are wrong to reduce their expectations of how far rates in Australia will fall, which implies that the strengthening in the Australian dollar will be reversed. Our interest rate forecasts are consistent with both the Australian and New Zealand dollars weakening to around US$0.70 this year.