By Mike Jones, Currency Strategist, Markets, BNZ

The NZD continued to grind higher overnight, underpinned by a further steadying in risk appetite and heavy NZD/EUR buying. The NZD/USD currently sits at one-month highs around 0.8030.

Fractious EUR/USD trading dominated the overnight session as fear and confusion over the plight of Spain set in once again. The net result is that the EUR has tumbled to fresh lows against a range of currencies. The NZD/EUR climbed to a fresh all time high above 0.6560.

Back in January, we suggested the NZD/EUR could 'peak' around 0.6500-0.6600. With the cross now having reached this level, investors are understandably wondering if the cross can go even higher. There is no doubt the European growth outlook has deteriorated in recent months and there is a reasonable chance the ECB loosens policy further. The NZ economic outlook, while hardly rosy, is far brighter. We expect 3.0% GDP growth in NZ this year, compared to the -0.5% expected for the Eurozone. These cyclical tailwinds should keep the NZD/EUR well supported. However, our new terms of trade adjusted PPP model (see here for details) suggests the long-run equilibrium of the NZD/EUR is around 0.5800. This suggests a push above 0.7000 may be a bridge too far for the cross.

Alongside NZD/EUR buying, a night of solid gains across equity and commodity markets also bolstered NZD demand. Soft commodity prices in particular continue to surge as the US drought worsens. Corn and soybean prices are now at all-time highs, while wheat prices at the highest level since 2008. The prospect of some of this strength filtering through to dairy prices likely explains some of the recent NZD enthusiasm.

For today, keep an eye out for NZ migration and credit card spending figures (out at 10:45am and 3pm respectively). However, for the NZD/USD, the key driver is still offshore risk sentiment. Should this remain buoyant, we should see the NZD/USD push through June's 0.8080 high in coming sessions.

Majors

Familiar themes prevailed overnight. EUR selling was again the order of the day. However, broader risk sentiment held up admirably, allowing the 'growth-sensitive' AUD and NZD to outperform.

It certainly wasn't a straight line lower in the EUR/USD. The single-currency was tossed around in a wide 1.2240-1.2320 range as investors tried to clarify reports on how EFSF aid could be used for Spain.

In the end though, sellers won the day. A disappointing Spanish bond auction (see Fixed Interest), surging Spanish bond spreads, chatter of EUR selling from the Swiss National Bank, and a nasty set of Italian industrial orders figures ensured resistance at 1.2330 continued to cap the EUR/USD topside. Moreover widespread selling of EUR crosses saw many of the majors (GBP, CAD, AUD, and NZD) notch up multi-year highs against the struggling EUR.

Outside of Europe, it was pretty much plain sailing. Weaker US data was shrugged off as the US second quarter corporate earnings season continues to impress. Of the 103 S&P500 companies that have reported so far, 66% have exceeded expectations. Modest gains in US stocks shored up broader risk appetite. Commodity prices also climbed, led by a 3% gain in oil prices. Against this backdrop, the AUD/USD shot up to a three month high above 1.0430.

With just second tier data on the calendar, it should be a relatively quiet end to the week. But, to the extent that hopes of more Fed easing explain some of the buoyancy in risk appetite, we should see 'growth-linked' currencies remain well supported in the near-term. Next week's preliminary Q2 US GDP figures will provide the next important test of QE3 expectations. A weak number (say around 1% annualised) is likely needed to further bolster US easing hopes and keep the 'risk' rally intact.