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Update: Australia dollar sinks on inflation blow, NZ dollar hit by trade

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The Australian dollar dropped more than a full cent on Wednesday, after a soft inflation reading prompted markets to price in a greater chance of an interest rate cut, dragging its New Zealand peer lower.

[SYDNEY] The Australian dollar dropped more than a full cent on Wednesday, after a soft inflation reading prompted markets to price in a greater chance of an interest rate cut, dragging its New Zealand peer lower.

The Australian dollar weakened to US$0.7650, after data showed core inflation slowed to the lowest on record in a major surprise.

Support lies at a key retracement level of US$0.7622.

The Aussie also fell more than 1 per cent against the euro, yen, pound, Swiss franc Against its kiwi cousin, it lost 1.5 per cent, marking the biggest one-day loss since mid-January.

The headline Australian consumer price index (CPI) fell 0.2 per cent in the first quarter, confounding forecasts of a 0.3 per cent increase. A key core measure inflation rose just 0.2 per cent in the first quarter, below the Reserve Bank of Australia (RBA)'s projections. "It is consistent with their easing bias and probably strengthens it," said Su-Lin, a senior economist at RBC Capital Markets. "I don't think this number will be enough for (a move) next week," she said, but still sees two rate cuts in the second half of the year.

Interbank futures jumped, implying around a 50-50 chance of an easing to a record low of 1.75 per cent at the RBA's policy meeting next week, from one-in-10 before the data.

Australian government bond futures rallied, with the three-year bond contract up 10 ticks at 98.060. The 10-year contract added 3.5 ticks to 97.3900 in a bullish steepening of the curve.

The 20-year contract eased 1.5 ticks to 96.7650.

The spread between 10- and 3-year cash bonds increased to 67 basis points, the widest since mid-February.

The New Zealand dollar also struggled after domestic data showed a wider-than-expected trade deficit.

It fell 0.3 per cent to US$0.6880 after New Zealand posted an annual trade deficit of NZ$3.838 billion (S$3.56 billion), the largest in seven years.

Economists polled by Reuters had forecast a monthly surplus of NZ$475.5 million and an annual deficit of NZ$3.56 billion.

The next focus is on central bank announcements, beginning with the Federal Reserve and followed by the Reserve Bank of New Zealand.

Most analysts polled expect the RBNZ to hold rates at 2.25 per cent on Thursday, but markets are pricing an easing as a 50-50 chance.

"Trading should be light ahead of tomorrow morning's double header with the FOMC and RBNZ statements out within a few hours of each other," said BNZ Currency Strategist Jason Wong.

"The combination of a slightly more hawkish Fed and an RBNZ easing would help take the NZD below US$0.6800." New Zealand government bonds were mixed across the curve with yields slightly lower at the short end and slightly higher at the long end.

REUTERS