By Roger J Kerr
Whilst the local economic and media commentators debate the pro’s and con’s of the Reserve Bank of New Zealand cutting official interest rates for the fourth time this year, the NZ dollar FX market appears to have already moved past that event and have priced the NZ currency higher for other reasons.
The justifications for another 0.25% decrease in the OCR rate to 2.50% at this time have waned in recent weeks as local economic data has printed on the stronger side and business/consumer confidence has recovered from the mid-winter dip when dairy prices plunged.
More observers are coming to the view that the RBNZ is better to wait and see how inflation increases over the next few months as the substantial exchange rate depreciation earlier in the year finally hits the retail stores. The RBNZ is not forecasting the annual inflation rate to stay below 1.00% ad infinitum as several bank economists are now forecasting.
The more medium term and fundamental reasons why the NZ dollar has appreciated to 0.6740 from the 0.6500 area, ahead of upcoming RBNZ and US Federal Reserve monetary policy announcements, may be summarised as follows:-
- The FX markets do not see the RBNZ cutting the OCR this week, and even if they did the RBNZ might then signal they are in “neutral” mode as the RBA have recently done. The FX markets have already messaged their verdict on the OCR decision by bidding the Kiwi higher ahead of the expectation of “no change”.
- The Kiwi dollar follows the AUD against the USD and the AUD has been a standout performer over recent weeks across global forex markets. The international investor sentiment is turning back in favour of the AUD and Aussie economy due to their non-resources sectors really improving and the RBA not cutting interest rates any further. The RBA correctly concluded that lower interest rates from 2.00% will not make a scrape of difference to investment in the economy. The Australian sharemarket remains undervalued relative to other over-valued equity markets around the world. The AUD is also benefiting from hedge funds and currency investors seeking an alternative to the weakening Euro as the ECB loosen monetary policy further.
- Global currency players would not have missed the importance of two recent positive developments for the NZ economy as a trading nation. China’s change away from the single child family policy fundamentally means more babies and thus importing more dairy products from NZ to feed them. The Trans Pacific Trade Partnership is also a longer term positive for the NZ export-based economy.
- Whilst extremely volatile up and down, wholemilk powder prices are now pricing higher to US$2,400/MT (futures prices) which indicates Chinese demand is fairly solid at the commencement of their seasonal buying period over coming months. Overall, our export commodity prices (outside of dairy) are tracking very well and the Terms of Trade Index (import and export prices) has not reduced to the lower levels the RBNZ were expecting back in their June and September economic outlooks. Sheep, beef, horticulture and forestry export prices, when combined with the lower NZD value compared to 12 months ago, are all at value-enhancing levels for the economy.
The foreign exchange market has already priced in a “no cut” outcome this Thursday, therefore further NZ appreciation to above 0.6800 may prove to be short-lived as all the buying interest has already occurred. A 0.25% decrease from the RBNZ would now be more of a surprise for the FX markets and thus the NZD/USD rate would fall by two or three cents if this was to be the decision.
Based on higher interest rates (relative to others) and superior economic performance over coming years the NZ dollar can be expected to make gains against the Japanese Yen, UK Pound and the Euro from current cross-rate levels. However, reduced interest rate differentials between Australia and New Zealand now point to the NZD/AUD cross-rate having a bias lower to 0.8800/0.8900 from the current 0.9200 area.
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Roger J Kerr is a partner at PwC. He specialises in fixed interest securities and is a commentator on economics and markets. More commentary and useful information on fixed interest investing can be found at rogeradvice.com