By Wayne Cole and Charlotte Greenfield
SYDNEY/WELLINGTON, Nov 17 (Reuters) - The Australian and New Zealand dollars were both heading for sizable weekly falls on Friday as their yield buffers over the U.S. dollar shrank to the smallest in over 17 years, undermining their appeal as carry trades.
The Australian dollar AUD=D4 was huddled at $0.7593 and nursing losses of 0.9 percent for the week so far.
Its kiwi counterpart edged up to $0.6863 NZD=D4 and away from a low of $0.6836, but was still down 1 percent on the week.
The Aussie was thumped mid-week by surprisingly soft wage data and never recovered. A solid jobs report provided little support since employment has been surging for a year now but has had absolutely no impact on wages.
The Reserve Bank of Australia (RBA) acknowledged the new normal last week by sharply cutting its inflation forecasts.
It now no longer expects underlying inflation to reach the floor of its 2 to 3 percent target band until mid-2019, over a year later than originally hoped.
Paul Dales, chief economist Australia at Capital Economics, suspects core inflation will not reach 2 percent until 2020 at the earliest.
"The RBA has started to learn from the recent experience of some other economies, particularly those where inflation has not risen much even though the unemployment rate has fallen to multi-decade lows," said Dales.
"Such a lesson could significantly influence the future path of interest rates."
Even Goldman Sachs (NYSE:GS), one of the die-hard hawks, has given up on its prediction of a hike next February and shifted out to May. The market is still far from convinced, with futures 0#YIB: putting the probability of a move in May at 16 percent.
A hike in the 1.5 percent cash rate is not fully priced in until February 2019.
In contrast, the Federal Reserve seems hell bent on tightening U.S. policy.
San Francisco Fed President John Williams on Thursday said it would be "perfectly reasonable" to raise rates in December and up to three more times next year.
Such an outcome would take the U.S. cash rate above Australia's for the first time since 2000, a sea change bond markets have already embraced.
The gap between Australian and U.S. two-year government yields has dwindled to 9 basis points, down from 60 in September and the smallest spread since mid-2000.
Likewise, yields on New Zealand government two-year debt NZ2YT=RR are just 29 basis points above those in the U.S., with the spread having more-than-halved since September.
Australian government bond futures paused after two strong sessions, with the three-year bond contract YTTc1 steady at 98.040. The 10-year contract YTCc1 eased half a tick to 97.2950, having hit a 10-week peak on Thursday. (Editing by Shri Navaratnam)