The Reserve Bank of New Zealand (RBNZ) may hike rates by 25 basis points to head off inflationary pressures when it meets this Thursday, making it the first major central bank in the developed world to start normalizing monetary policy.
Official data on Jan. 21 showed the consumer price index rose 0.1 percent in the three months to Dec 31, confounding expectations for a 0.1 percent fall, and pushing the annual rate up to 1.6 percent - the highest since March 2012, Reuters reported. The central bank had forecast a fall of 0.2 percent.
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"The risk of an early start to the RBNZ's hiking cycle has clearly risen," said Mansoor Mohi-uddin, head of foreign exchange strategy at UBS, after economic data showed "strong growth with higher-than-expected inflation, a firm manufacturing PMI (purchasing managers' index) and buoyant consumer confidence."
Jeffrey Halley, Senior Manager, FX Trading at Saxo Capital Markets said currency markets are "underpricing" the risk of tightening this week. There's a "very high chance they're going go" and raise the OCR (official cash rate) by 25 basis points, he said.
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Todd Elmer, head of G10 FX strategy for Asia ex-Japan at Citigroup also believed the RBNZ would act this Thursday, adding that the New Zealand dollar may head to parity against its Australian counterpart within the next six months.
Mohi-uddin at UBS said that the Australian dollar is likely to "trade heavily" against the NZD into the RBNZ meeting, with the pair possibly testing its 2005 low of 1.0430.
However, those calling for a rate hike are in a minority and the consensus view points to an increase only in March. Expectations are evenly balanced with interest rate swaps implying a 48 percent probability of a rate hike.
A Reuters poll of 17 forecasters found only three banks - ANZ, HSBC and Citibank - ready to predict an increase this week.
A 25 basis point cut in the OCR as early as this Thursday is "bold, to say the least," said Ilya Spivak, Currency Strategist at FXCM Live. Meanwhile, Rob Rennie, Westpac's global head of FX strategy in Sydney said the RBNZ will only start an "aggressive" tightening cycle hike in March.
The benchmark official cash rate has been at an all-time low of 2.5 percent for nearly five years. The RBNZ moved to raise rates to 3 percent the second half of 2010 but reversed that move after the February 2011 earthquake. The New Zealand dollar bought 82.33 U.S. cents at around 9.42 a.m. Singapore time.
— By CNBC's Sri Jegarajah. Follow him on Twitter @cnbcSri