NZD strengthens on hotter inflation print

The kiwi has strengthened this week, with the standout driver being Q2CPI data that came in above the RBNZ's own projections and a touchabove market expectations (for annual growth). Inflation rose 1.5% QoQ,above our forecast of 1.4% QoQ, with the annual rate lifting to 4.1% YoY,the highest in over two years and above both our call and the 4.0% YoYconsensus. Both our forecast and the market median sat comfortablyabove the RBNZ's projection of 1.3% QoQ and 3.9% YoY.Transport was the largest contributor to the quarterly move, rising 6%QoQ as fuel prices spiked on the back of the Iran conflict, with petrol up20.1% and diesel up 50.3%. That said, non-tradable inflation easedslightly to 3.4%, with quarterly annualised growth slowing to its lowestpace since mid-2020, suggesting domestic pressures may be starting tocool. Tradable inflation, by contrast, jumped to 4.9% from 2.5%, largelyreflecting the fuel driven spike. In our view, the data showed that core measures remained relativelycontained, with CPI excluding fuel slowing to 2.9% and CPI excluding fuel,food and household energy easing to 2.5%, both within the RBNZ's targetband despite sitting on the elevated side. Indeed, looking ahead, weexpect headline inflation to ease to 3.5% by year end as the fuel spikefades, though risks are skewed to the upside given ongoing geopoliticaluncertainty. This continues to support our call for just one more OCR hikethis year in September, followed by a further move in February 2027 thattakes the OCR to 3.0%.On the Middle East, oil prices have pushed higher this week as the risk offurther supply disruption grows. US strikes on Iran have continued, withTrump warning of retaliation after the deaths of three US soldiers, whileIran has kept up attacks on shipping in the Strait of Hormuz and targetedUS military sites across the region. Prices jumped further on reports thatYemen's Houthi militants would impose a ban on maritime traffic fromSaudi Arabia, threatening one of the few remaining routes able to offsetsome of the collapse in Hormuz traffic. Oil price gains were cappedsomewhat by reports of a proposed 10 day ceasefire aimed at revivingthe largely collapsed US-Iran peace deal. Tanker traffic through theregion has fallen sharply again, and the US blockade of Iranian portscontinues to constrain trade. This disruption has spilled over into gas markets too, with European LNGfutures hitting four month highs on concerns over winter supply. Storagelevels are currently around half full, a touch below the typical level for thistime of year, leaving limited buffer should the conflict persist or a colderthan expected winter lift demand. Either scenario points to further upsiderisk for gas prices ahead.