The RBNZ Monetary Policy Statement this Thursday may surprise the financial markets in being somewhat more “dovish” on the outlook for the economy next year.

The RBNZ look to trends in the residential property market as a key indicator for the strength of the domestic economy. Recent data for house sales and building permits have been weaker and this should cause the RBNZ to be less optimistic about GDP growth in 2011. Even though the RBNZ acknowledge that the super high export commodity prices is very positive for the economy, they see housing and retail continuing to be week and thus off-setting the export growth. They are also convinced that dairy farmers will apply all their additional income to repaying debt and not spending/investing it. Given these underlying economic assumptions, it would not surprise me that the RBNZ lower their current 2.5% GDP growth forecast for 2011 come Thursday.

I think they will be making a mistake in doing this and will be forced by stronger economic numbers by March/April to revise their growth forecast back up again. They will also then by behind the 8-ball in removing the emergency monetary stimulus and getting monetary conditions back to “neutral”. They will also be forced to concede that stronger than expected GDP growth elevates future inflation risks, thus official interest rates could be increasing a lot faster in mid-2011 than what most realise.  

The continuing high export prices and stronger business confidence indices do not suggest GDP growth below 3.00% next year. Earlier this year, rising business confidence turned out to be a false hope and not much more. Today the rising confidence appears to be much more firmly based on forward orders, sales and profits all tracking much better. 

Despite all the economic analysis and scenario setting, at the end of the day the rate of GDP growth may well come down to whether it rains over the balance of December or not. A summer drought pulling down agriculture production would certainly deliver actual 2011 GDP growth near to the current pessimistic forecasts of sub-2.00% from Standard & Poors and NZIER. Perhaps the RBNZ economists should be paying more attention to the long-range weather forecasts and forgetting about their love-affair with the residential property market. 

USD set to resume its strengthening trend

Day-to-day volatility in the NZD/USD exchange rate continues unabated, providing a multitude of risks to importers and exporters exposed to currency movements. After reaching highs of 0.7990 nearly a month ago, the Kiwi has reversed sharply to lows of 0.7400 last week. However, the one-way traffic downwards was abruptly halted on Friday 3 December when weaker than expected US employment data caused USD selling against the Euro and Australian dollar. The Kiwi dollar followed those two currencies up, rising from 0.7500 to 0.7660 in thin, illiquid markets in the US trading time-zone. Once again it is international currency markets that are behind all the NZ dollar movements, with local economic data and events having limited impact. 

In looking back at the massive shifts in global currency values over recent weeks, there is no question that the sentiment has turned much more in favour of the USD. Following the US Federal Reserve quantitative easing in monetary policy in early November the USD has strengthened from $1.4200 to $1.3000 against the Euro. The USD gains sending the Kiwi dollar down from 0.7900 to 0.7400. The rebound upwards from $1.3000 to $1.3400 in the EUR/USD rate last week appears to be only temporary, based on a the higher US unemployment rate to 9.8%. US employment statistics are very volatile month to month with past months prone to major revisions.

Overall, US economic data is on the improve and this should flow into stronger monthly jobs numbers over coming months. Given the debt woes in Europe will continue for some time yet, it is very hard to make a case for the Euro to hold the current $1.3400 level. In the lead-up to the Christmas holidays FX traders, hedge funds and fund managers will continue to unwind underweight USD positions and therefore will use the current rebound in the EUR/USD rate to $1.3400 to sell Euro and buy USD’s. The currency markets are now interpreting stronger US economic data as positive for the US dollar, therefore a stronger USD to $1.2500 against the Euro looks set to pull the NZD/USD rate back to near 0.7000.

The Reserve Bank of New Zealand’s quarterly monetary policy statement on 9 December is likely to be more “dovish” on the economy than what the markets are generally expecting. The RBNZ will be taking recent weaker housing data as a justification for their more negative outlook on the economy in 2011. Governor Bollard has been jawboning the NZD down in recent speeches as he knows that the export-led recovery in the economy needs a lower Kiwi value to sustain itself. The monetary policy statement should continue in that same vein of interest rates being lower for longer in 2011. Expect to see the NZD being sold in the markets after the statement is released. Alan Bollard will certainly be careful not to say anything that could be interpreted as positive for the NZD value. The RBNZ might be as downbeat on their future assessment for the NZ economy as Standard & Poors were two weeks ago with their “negative outlook” announcement. 

The Reserve Bank of Australia has hinted that it is near the end of their interest rate increases. Some of the recent domestic economic data in Australia has not been as strong as it was earlier in the year, so the RBA are less inclined to push interest rates higher above 5.00%. The AUD/USD rate will continue to be influenced by Chinese economic news and commodity prices. Monetary policy is being tightened in China, so it is hard to see commodity prices going higher in the short term. 

Whilst further USD strength should take the NZD/USD rate down to 0.7000 and maybe below that level over coming months, rising NZ interest rates in the middle of next year may single the NZ dollar out as the only economy increasing their interest rates at that time and thus send the NZD right back up again.