Roger J Kerr says 'there is no question' the RBNZ will have to bring forward the timing of official interest rate rises

By Roger J Kerr

The foreign exchange markets have already delivered their verdict on the political change that has taken place in New Zealand over the last six weeks.

The Kiwi dollar, as expected, has been sold heavily in the markets on the news early last week that the “Kingmaker”, Winston Peters with just 7% of the popular vote would form a coalition government with the Labour Party.

The NZ dollar plunged down four cents against the USD from 0.7200 to a low of 0.6820 on 27 October.

On an overall Trade Weighted Index (TWI) basis the NZ dollar has depreciated 6.5% over the last two months from 78.00 to 73.12.

All the cross-rates for the JPY, EUR, AUD, GBP and CAD against the NZD have also reduced. However, the cross-rate decreases have been less than the NZD/USD movement as most of these currencies have lost ground themselves to a resurging US dollar value on global forex markets.

For the meantime it appears that the knee-jerk reaction by offshore hedge funds and currency traders to sell the Kiwi dollar has been exhausted.

The selling has run its course.

Bounced off lows

The NZD/USD rate looks like it has bounced off the lows of 0.6820 and at the time of writing and corrected back up to 0.6870.

The majority of those offshore investors that wanted to get out of New Zealand or reduce their NZ exposures have now already done so.

Further heavy selling below 0.6800 now seems less likely.

Adding to the selling would have been local fund managers, who typically hedge against an appreciation of the Kiwi dollar on their international equity portfolios; they have been unwinding those hedges and selling the Kiwi in the process.

The offshore reaction to the political machinations that have taken place in New Zealand over recent weeks is totally understandable, as they would have failed to comprehend how the highest polling political party really had no leadership role or say in who the new government would be.

Something negative

Naturally, they would have concluded that something negative was going on in New Zealand that they were not aware of, as the performance of the economy with export commodity prices at 40-year highs was very positive indeed.

However, as previously commented on in this column, the general election was not contested over the economy, jobs and financial matters as they were all going fairly well for the vast majority. Instead, many voters were influenced by immigration, the housing market and environmental issues, thus the result was a hodgepodge and a resultant clear shift to the left on economic and social policies.

Over coming months the FX markets will be waiting to see the true colours of the new government in New Zealand.

There is already some back-tracking starting to appear on policies such as foreign investment into existing residential property, maybe now a stamp duty tax rather than a complete ban.

The markets will still be seeking reassurance from the new Finance Minister, Grant Robertson that all the spending promises are not going to blow budget surpluses into massive deficits and increased debt.

The required fiscal update due before the end of the year will the focus for this.

New directions

The financial markets will also be looking to see what direction new Trade and Export Growth Minister, David Parker takes with the TPPA free-trade negotiations.

New Zealand has always campaigned very hard in global trade circles for more access into foreign markets for our export products. If we turn-coat from free and open markets and put up barriers to foreign investment into New Zealand our credibility would rightfully be questioned.

Local economists are all now hastily revising their inflation forecasts for 2018 as the exchange rate is much lower than previously factored in, thus tradable inflation will be moving upwards over the next 12 months as imported items increase in price.

Inflation will also be pushed up by rising wages from the increased minimum wage policy and new restrictions on immigration numbers.

Construction and food prices continue to increase for their own unique supply/demand reasons.

Add on rising crude oil prices and all of a sudden the inflation outlook is significantly different to the benign picture painted by the RBNZ only two months ago in August.

‘No question rate rises will be brought forward’

There is no question that the RBNZ will be forced to bring forward the amount and timing of OCR interest rate increases in 2018 from the current rate of 1.75%.

There will be considerable debate as to when the RBNZ will be convinced by the weight of evidence to change their forward monetary policy guidance.

The interim Governor in place until March next year, Grant Spencer, may be reluctant to be the architect of such a change in stance and he may well leave it for the new Governor to signal.

The foreign exchange markets will not wait for months on how the RBNZ might change their view.

They will determine that interest rates are rising sooner than previously expected in New Zealand and this will underpin the Kiwi dollar and prevent further depreciation.

Changed outlook

On the changed inflation outlook alone the NZD/USD should trade closer to 0.7000 over coming months than at lower levels.

The rising oil prices may suggest a stabilisation and perhaps movement back up in whole milk powder prices as some of the oil producing buyers of NZ dairy products have more cash to buy imported protein.

The US dollar itself should continue to recover the ground it lost to the Euro earlier in the year (the EUR/USD rate moving from $1.05 to $1.20, now back to $1.16).

All the cross-rates to the NZ dollar may well “double-whammy” back up from here with the NZD recovering back to 0.7000 against the USD, however the major currencies weakening against the stronger US dollar.

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Roger J Kerr contracts to PwC in the treasury advisory area. 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