Australia, New Zealand dollars on shaky ground as support buckles

By Wayne Cole

SYDNEY, Oct 1 (Reuters) - The Australian and New Zealand dollars began a new month still on the defensive as surging US bond yields buoyed the greenback, while domestic data showed Australia's housing market buckling beneath the weight of rising borrowing costs.

The kiwi dollar slid to a one-year trough of $0.5618 , as a break of $0.5627 support triggered fresh short selling. The currency shed a steep 4.8% last month and seems destined to test 2025 troughs at $0.5581 and $0.5485.

The Aussie was pinned at $0.6946 , having shed 0.6% overnight when inflation data came in just below the market's hawkish expectations. Major support lies at $0.6913 and $0.6867.

While the miss on inflation was minor, it was still enough to help cushion domestic bonds from a continuing rout in US debt. Yields on 3-year notes edged up to 4.976%, but the spread over Treasuries shrank to -1 basis point compared with +27 basis points a month before.

Markets also scaled back wagers the Reserve Bank of Australia would hike rates again in November or December, following this week's increase to 4.60%.

The fourth hike this year is wreaking havoc on the housing market with prices sliding more than 5% from their peaks, the worst downturn in three decades.

Yet the RBA on Thursday played down the damage, saying house prices could fall a further 20% and still only 5% of borrowers would be in negative equity on their homes.

Much now depends on what the consumer price report for the whole third quarter shows later this month, with monthly figures pointing to a rise in core inflation of 1.0%.

"We would characterise such a result as a "notable miss", putting the RBA in a very difficult position," said Andrew Ticehurst, an economist at Nomura.

"Such higher readings would extend the delay in returning inflation to target, and the question of whether policy has been tightened sufficiently has not been fully resolved," he added. "Our base case is the RBA cycle is over, but flag a material risk that another hike may be required."

Markets remain certain the Reserve Bank of New Zealand will have to tighten further, but are divided on whether it will come at the next meeting on October 28 with the probability put at 58%.

The current 2.75% cash rate is seen peaking at 3.75% or higher, far above the RBNZ's own projection of 3.2%.