By Swati Pandey and Charlotte Greenfield
SYDNEY/WELLINGTON, Dec 19 (Reuters) - Australian government bonds surged to 1-1/2-year highs on Wednesday, as collapsing oil prices sent a disinflationary signal across world markets while activity in currencies was muted.
The Australian three-year bond contract YTTc1 jumped 2.5 ticks to 98.125, a level not seen since mid-2017. The 10-year contract YTCc1 added 3.5 ticks to 97.610. New Zealand 10-year bond prices NZ10YT=RR climbed to the highest since October 2016.
The rally in bonds mirrored U.S. Treasuries, with investors now speculating the Federal Reserve will hold off on raising rates any further after its policy meeting later in the day following an eye-popping 5 percent fall in oil on Tuesday.
In currencies, the Aussie AUD=D4 was up 0.2 percent at $0.7195, staying in sight of a recent 1-1/2-month trough of $0.7151.
The New Zealand dollar NZD=D4 gained for a third straight session to $0.6866, but was still within spitting distance of a recent three-week low of $0.6779.
"The Fed is expected to raise rates but with share markets pressured, global growth slowing, and a cacophony of criticism from U.S. President Donald Trump, the potential for a surprise has grown over the last two weeks," said Steven Dooley, currency strategist at Western Union Business Solutions.
In a tweet overnight, Trump said that it was 'incredible' that the Fed is even considering raising rates given the global economic and political uncertainties.
So far, the futures market 0#FF: is sticking with a two-in-three chance of a rate increase on Wednesday.
But, there are growing signs of cooling in the global economy while investor confidence is deteriorating, adding to pressure on the Fed to abandon its commitment to yet more hikes.
A Bank of America Merrill Lynch (NYSE:BAC) investor survey showed more fund managers were expecting world growth to weaken over the next 12 months, the worst outlook in a decade. of easing demand in a slowing economy and oversupply have hit oil prices in recent months with Brent LCOc1 sliding 35 percent since October.
Falling oil is also likely to weigh on Australian consumer prices and hurt the country's terms of trade given it is a large exporter of liquefied natural gas.
That will also add pressure on the Reserve Bank of Australia's (RBA) rate outlook, with investors now pricing in a steady policy well into 2020. 0#YIB:
The RBA has left its cash rates at a record low 1.50 percent since last easing in August 2016, awaiting a pick-up in inflation.
In New Zealand, a fortnightly dairy auction yielded a flat outcome for whole milk powder - a key New Zealand export. official data showed New Zealand's current account deficit had widened in the third quarter. by Jacqueline Wong)