Last Thursday’s statement (which accompanies the OCR review) from RBNZ Governor Alan Bollard was an interesting piece of prose. Earlier in the week inflation numbers were much lower than forecast, Fonterra had lowered their milksolids payout forecast and business confidence was down – all relatively negative developments for the NZ economy. Add on Europe potentially heading into recession and bank borrowing margins heading up again, the first three paragraphs of Mr Bollard’s update was understandably downbeat and expressing some concerns. However, the last sentence in paragraph four completely contradicts what was stated above it by saying that interest rates will gradually be increased if the impact on the NZ economy from the European crisis is only mild. Why specifically mention interest rate increases at this point in time (even if it is conditional) if all it will do is push the NZ dollar higher?

Predictably, the financial markets tightened monetary conditions further after the OCR statement as the NZD shot up one cent against the USD. The RBNZ should know from their own bitter past experiences that it does not make a lot of sense to make statements that they should know will appreciate the NZ dollar when only a few short weeks ago the Governor was busily jawboning the NZD down as its over-valued position was damaging the real economy.

The RBNZ did not have to include that last sentence at all; however by including it they have tightened monetary conditions at a time when the opposite is required i.e. the Reserve Bank of Australia will be cutting their OCR tomorrow as the high AUD ravages the Aussie economy. Unhedged USD exporters will be rightfully aggrieved at the RBNZ statement causing the NZD to go higher.  

Pre-conditioning the financial markets and participants in the economy so they know what to expect from the RBNZ under certain conditions is all very well. However, the art of monetary policy management by the RBNZ also includes knowing when to leave stuff out of official announcements. Unwinding the emergency monetary stimulus (OCR slashed to 2.5%) put in place in early 2009 was always going to be a challenge for the RBNZ and here we are 2 ½ years later still trying to navigate a way out. The way I see it is that the timing and speed of OCR interest rate increases in 2012 are entirely dependent on what happens to the NZ dollar exchange rate. If the Kiwi dollar remains above 0.8000 against the USD, export industries struggle and GDP growth will be well below current +3% forecasts, thus interest rate adjustments upwards will be delayed and smaller. Should the NZD/USD exchange rate depreciate to the low 0.7000’s over coming months (due to weaker EUR and AUD currencies) the export sector will perform better (thus investment and jobs) and +3%  GDP growth will be achievable in 2012. Interest rate increases will be able to be phased-in under this second scenario as the lower NZ dollar automatically loosens monetary conditions in the economy.  

The NZ dollar currency movements play a pivotal role in our economic performance  and will continue to do so in the future. According to historical correlations, if the NZD/USD exchange rate remains above 0.8000 cents the economy will fall back into recession over the next 18 months. Of course, agricultural commodity prices play a large role as well in driving our economic performance; however the RBNZ cannot ignore the importance of the exchange rate in any economic growth projections.

 
NEW ZEALAND DOLLAR MARKET COMMENTARY

Yen intervention pulling the Kiwi dollar down

The last time the Bank of Japan directly intervened in the JPY/USD currency market back in March 2011, the NZD was sent into a downward tail-spin as retail FX speculators were forced to unwind their long NZD/short Yen punting positions. The Bank of Japan intervened in the FX markets again today, selling the Yen and sending JPY/USD rate from 75.50 to 79.00 in a matter of minutes. The timing of the intervention is very interesting ahead of the G20 leader’s summit meeting in Cannes, France this week. Maybe the Japanese want to be seen to be doing their bit to erase financial market distortions that could play a role in sending the global economy into a double-sip recession.

A weaker Yen and weaker Euro exchange rate, as a result of the detail from the Euroland debt agreement disappointing the markets, both point to the Kiwi retreating from 0.8200 as rapidly as it went up. The EUR/USD exchange rate above $1.4000 does not look too sustainable against the prospect of the ECB cutting Euro-Zone official interest rates this Friday and the distinct possibility of Europe heading into economic recession despite the top-level agreement on the debt crisis. A 10% depreciation in the Euro from $1.4000 to $1.2500 over coming months should pull the Kiwi lower by a similar percentage to below 0.7500 against the USD. If other central banks join-in with the Japanese intervention on the Yen, that level of movement for the EUR/USD rate looks more likely than not.

Local economic news has all been negative for the Kiwi dollar over this last week. Lower than expected inflation, the Fonterra milksolids payout forecast cut and faltering business confidence all point to a justification for New Zealand Inc to be worth a bit less on its stock price. They also suggest interest rates remaining lower for longer and the removal of any pricing-in by the FX markets of future interest rates increases.

The final important factor for near-term NZD direction is the AUD/USD movements. The Aussie dollar appears vulnerable to selling on market profit-taking (following the spectacular run-up from 0.9500 to $1.07 over the last month), RBA interest rate cuts and Bank of Japan intervention selling of the Yen.