Australia, NZ dollars rebound as yields surge on rate repricing

By Wayne Cole

SYDNEY, March 20 (Reuters) - The Australian and New Zealand dollars held firm after another head-spinning rally on Friday, with the mounting risk of energy-driven inflation sending bond yields surging and widening the spread over U.S. debt.

Hawkish tones from several central banks overnight only stoked wagers for more interest rate hikes in Australia and an early return to tightening across the Tasman.

The Reserve Bank of Australia has already lifted rates twice to 4.10%, and markets imply a 56% chance it will move again to 4.35% in May. Indeed, swaps suggest a real risk rates could peak at 4.85%, levels not seen in 17 years. 0#AUDIRPR

"We continue to expect another rate hike in May, though that is seven long weeks away and recent weeks have highlighted just how quickly the global backdrop can shift," said Lucinda Jerogin, an associate economist at CBA.

"While we expect the conflict to persist and energy prices to rise, risks to global growth are building."

The hawkish shift saw the Aussie up at $0.7084 AUD=D3, after bouncing 0.9% overnight in another of the wild swings that have dominated trade since the start of the Middle East war. It was 1.5% firmer for the week so far, but just as likely to test $0.6980 support again should risk sentiment sour anew.

The kiwi dollar held at $0.5880 NZD=D3, having rallied 1.3% overnight as domestic short-term rates surged to one-year highs. Strong support lies at $0.5775, with resistance around $0.5891 and $0.5963.

Both currencies were underpinned by steep rises in bond yields as investors wagered local central banks would have to tighten policy to contain inflation.

Australian three-year bond yields AU3YT=RR have climbed a staggering 48 basis points so far this month and briefly touched 4.745%, levels not seen since mid-2011. That saw the spread over Treasuries yawn out to a hefty 92 basis points.

In New Zealand, the key two-year swap rate NZDSM3NB2Y= has shot up 55 basis points since the war began to reach 3.473%, far above the 2.25% overnight cash rate.

Markets have shifted to imply a 50% chance the Reserve Bank of New Zealand could hike as soon as May, even as the domestic economy continues to struggle. 0#NZDIRPR

The head of the RBNZ is due to speak on March 24 about the impact of the energy shock and markets will be sensitive to the balance of risks between inflation and growth.