[DanRath]

The NZD is a cyclical currency which is explained by three factors: First, New-Zealand is a small and open economy closely linking its domestic performance with global growth. Secondly, agricultural exports make up the lion share of total exports. While agricultural exports are less elastic to global demand swings when compared to industrial commodities, the income changes in export destinations impact agricultural prices along with global weather patterns and other supply factors. NZ terms of trade are heavily impacted by price changes for dairy and other farming products. The third factor explaining the cyclical behaviour of the NZD must be seen in the context of the countries net liability position, which coming on the back of excessive current account deficits. When there is a global economic recovery cross border funding flows tend to pick up allowing currencies of countries with substantial net liability positions to rise. However, since March NZDUSD has gained 43% outperforming other high flyers such like the ZAR, AUD and SEK. The RBNZ suggested in yesterday’s interest rate statement: ‘For growth to be sustained in the medium term there is a need for improved competitiveness in the export sector and a continued recovery of household savings. This rebalancing is required to stabilise New Zealand’s external payments position. If the exchange rate were to continue its recent appreciation and/or the recovery in house prices were to undermine the improvement in household savings, then the sustainability of the present recovery will be brought into question.’ Indeed a too strong currency potentially undermines the rebalancing process. Household sector debt of 160% of disposable income is unsustainable and requires higher saving in order to repay debt. Most of this debt has been funded abroad and that investment income is negative by 7% of GDP. Hence, NZ could come under pressure from two sides: First if investors regard the credit risk as too high, triggering NZD rates and yields to rise disproportionally and thus killing the economic rebound. Secondly, the global economy falling into a double dip reducing cross border financial flows. The higher NZ debt levels at the time of global flows drying up, the bigger the destructive effect on the NZD. The RBNZ pointed out that the rally of the NZD has run out of proportion relative to domestic fundamentals and does not reflect NZ’s poor terms of trade. Export prices have fallen at the sharpest rate for 58-years suggesting upcoming trade and current account data will develop NZD bearish surprises. Hence, it would be logical for the RBNZ to intervene against its own currency. Since the economy is still weak and inflation declining un-sterilised intervention makes sense from a monetary policy point of view. In this sense the RBNZ is in a more comfortable position compared to 2007/08, when it unsuccessfully tried to weaken the NZD despite the need to run tight monetary conditions from a domestic / price targeting point of view.