Roger J Kerr says the twin risks posed by the struggling dairy sector and the overheating housing market are not being given enough consideration

By Roger J Kerr

As last week’s GDP data for the March quarter evidenced, the NZ economy continues to perform very well with robust expansion of 0.70% over the first three months of the year.

Measured against other comparable economies confidence is up, businesses are investing and expanding, the Government’s finances are in good shape, the Balance of Payments deficit has reduced, immigration remains strong and the construction sector is going gang-busters.

As exchange rates are relative prices, maybe it is no great surprise that the New Zealand dollar is outperforming other currencies as a favoured investment destination.

Our higher interest rates compared to others also assists such investment decisions.

The Trade Weighted Index (TWI) back above 75.0 is testimony to the gains made against the AUD and USD, in particular, over recent weeks.

Whilst the economic news on the surface is very positive and this is reflected in the latest appreciation of the NZ dollar, below the surface there appears to be two major undercurrents of risk lurking that have yet to influence currency investment decisions and thus the Kiwi dollar’s value:-

  • International dairy prices continue to bounce along the bottom, delivering a third year of losses and negative cashflow for dairy farmers supplying our largest industry. The recent increase in the NZD/USD exchange rate to above 0.7000 compounds the problem further. To date, increases in agriculture production (outside dairy) may have disguised and offset the negative impact from dairy on the wider economy. As bank lender patience in the dairy sector wears thin over coming months, the downturn in spending through provincial New Zealand will start to show up and the economic risk become more apparent.
  • The residential property market boom has not lost any momentum with the supply shortage, low mortgage interest rates and strong immigration driving prices higher. The risk to the economy, that everyone from the RBNZ to the Government is hoping to avoid, is that the housing asset bubble bursts badly, resulting in a wider economic impact of consumer confidence and retail spending plummeting.

The above two risks are not receiving much air-time (as yet) from local economic commentators, so the financial markets are not paying much attention to these potential negative economic developments. Ultimately they will have to. The foreign exchange market for the meantime seems to prefer to take its cue in pricing the NZ dollar value from the RBNZ’s statements and decisions, rather than contemplating the aforementioned undercurrents of risk.

Whilst continually talking of the need of a lower NZ dollar value, the RBNZ’s actions over the last seven months have directly resulted in the forex markets pushing the NZ dollar higher:-

  • The December 2015 cut to the OCR, however accompanying messaging was that it would be the last cut.
  • The March 2016 surprise cut to the OCR unfortunately immediately gazumped by the US Federal Reserve’s “go slow” signal on their interest rate increases, thus a weaker US dollar prevented the NZD from depreciating.
  • The late April 2016 decision to leave the OCR unchanged, when a surprise cut (following the RBA’s example) would have been effective in pushing the NZ dollar down.
  • The early June MPS again leaving the OCR unchanged, sending the NZD/USD rate skywards from 0.6800 to 0.7100.

The flip-flop signals and not taking the opportunities to drive the NZD down when they were available to the RBNZ, indicates that they are now more worried about the housing market than continually breaching the 1% to 3% inflation target.

The RBNZ have seemingly moved from forecasting the economy for the conduct of monetary policy, to attempting to forecast asset values (residential house prices).

Their late 2015 forecast of the Auckland housing market coming off in 2016 has not been accurate and thus their latest OCR decisions appear to be a reaction to that miss-read.

Our dairy farmers and food/manufacturing exporters to Australia are the ones paying the price for these monetary policy decisions.

The NZ dollar gains and a lack of USD strength offshore must force the RBNZ to cut the OCR at the next opportunity on 11 August.

Global investment and currency markets will have immediate reactions to the UK referendum result on exiting the EU, or not, this Thursday 23rd June (Friday afternoon NZ time).

The UK Pound can be expected to strengthen against the USD if the “stay” vote prevails, whereas a major Pound depreciation will result from a “leave” outcome.

The UK opinion polls are too close to call, however the polls were horribly wrong on the Scottish independence vote last year as the status-quo vote was stronger on the day. The bookies heavily favour a “stay” outcome, which would be the best result for the UK economy and currency.

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Daily exchange rates

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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