Another week has gone by and the local interest rate market is back into debating how the NZ economy will perform this year and that in turn will determine the timing of OCR increases later in the year.

Predictably, the RBNZ Governor was not as downbeat on the 2012 economic outlook last week as the benign picture being painted by the majority of local economic forecasters. The monetary policy prescription come June/September time will be determined by two sets of economic information:-

§  Backwards looking: What was the GDP growth in the December 2011, March and June 2012 quarters? If the outcomes are higher than RBNZ and market forecasts (I think they will be) the RBNZ will be re-thinking the economy and associated inflation risks.

§  Forwards looking: GDP growth forecasts for 2013 will be revised higher when it is seen that the European recession has not dragged Asian and US growth down. As always, the handbrake on the strong growth outlook will be the NZD exchange rate level. Consistent rates above 0.8000 against the USD this year will constrain export performance for sure.

Therefore, the new RBNZ Governor coming into office in September (see below) will have some tricky decisions to make about the inter-relationships of interest rates and the exchange rate on the NZ economy and thus monetary policy prescriptions at that time.

Candidates for RBNZ Governor’s job

Speculation has already started about who would be the best replacement for Alan Bollard in the hot seat at the RBNZ. I was somewhat surprised that Dr Bollard is not staying on for a third five-year term as experience counts for a lot in the position. However, we are very fortunate that there are a number of strong candidates for the role with the right credentials, reputation and background to do the job:- 

§  Grant Spencer: Currently Deputy Governor and well respected in financial market circles, however not well known outside the markets.

§  Murray Sherwin: Now heading the Productivity Commission, formerly a RBNZ Deputy Governor and widely respected economist. Murray should have succeeded Don Brash 10 years ago and may not be interested now.

§  Dr Arthur Grimes: Currently RBNZ Board Chairman so would have to resign from that position if he was putting his name forward. One of the prime architects of the independent central bank and inflation targeting structures in the late 1980’s.

§  Dr David Archer: Former head of economics at the RBNZ and these days at the Bank of International Settlements in Basle.

§  Adrian Orr: CEO of the NZ Superannuation Fund (Cullen Fund) and former RBNZ Deputy Governor and bank economist.

For what it is worth, if I was on the selection panel, I would favour Adrian Orr as having the right balance of economic, management and communication skills. Whoever is selected they will need to make sure their wife is not trading the NZD currency at the time, as happened to the Swiss National Bank Governor who was fired last week!

NEW ZEALAND DOLLAR MARKET COMMENTARY

NZ TWI unlikely to delink from USD Index direction

The overall value of the NZ dollar as measured by the Trade Weighted Index (“TWI”) is back above 72.0 again. The TWI has appreciated strongly since the lows of 67.0 in November. When the TWI gets up in the stratosphere near to 75.0 (as it did in early 2008 before the GFC on high NZ interest rates and again mid-2011 on capital flight inflows out of USD and EUR) the economy starts to suffer and it quickly reverses engines.

Many forces drive the NZ exchange rate direction. One important one is the overall value of the USD itself. The USD currency Index has been trending upwards since mid last year, however over recent weeks it has come back  on the news that the US Federal Reserve will maintain US interest rates at the very low levels until 2014.

Notwithstanding the recent USD Index pull-back, the NZ TWI has diverged away from the general USD direction and again appears over-valued and out of step at levels above 72.0. The historical negative correlation is reasonably robust with periods of a stronger USD causing a weaker NZ TWI. Based on superior economic performance of the US over Europe over coming years, my bet is that the USD Index will be heading higher. Therefore, I do not see the NZ TWI maintaining its current divergent trend above 72.0 and pick it to eventually head back down towards 65.0 at least.

However it will require shocks in global equities and/or Chinese economic  news to drive the NZD/USD exchange rate back below 0.8000 in the short-term