Roger Kerr posted on January 24, 2011 17:24
The OCR is reviewed again by the RBNZ this Thursday and again there will be no change. The moneymarkets have progressively moved the timing of the next OCR increase from March/April to July/September since the downbeat December MPS statement from the RBNZ and the negative September 2010 quarter’s GDP result just before Xmas. Mr Bollard has clearly stated that the RBNZ will not be increasing official interest rates until they see firm evidence of a sustained pick-up in economic activity this year.
Mr Bollard will also know that that this approach runs a high risk of another monetary policy management mistake being made this year, due to the extreme lag in receiving GDP figures from Statistics NZ (i.e. March 2011 quarter’s data coming out in late June 2011). By the time the RBNZ see proof of +3% GDP growth in 2011, the inflationary pressures will already be well advanced and they will be forced to increases official interest rates faster and in larger steps than what otherwise would be the case.
The art of monetary policy management is to pre-empt stronger growth (thus higher inflation risks) with pre-emptive adjustments to monetary conditions, as they take 12 to 18 months to have impact. The sad reality is that the RBNZ now have very little confidence in the accuracy of their own GDP growth forecasts, having been so far way from reality with their 2010 growth forecasts. They are now waiting for hard evidence of stronger growth in 2011 before lifting the OCR. They will find themselves well behind the 8-ball in this respect and will be forced to catch up in a hurry in the second half of the year. The risk and damage to the economy from this anticipated monetary policy miss-judgement will be via resultant exchange rate movements, not market interest rate movements.
Lifting the OCR from 3% to 5% later this year will only bring official interest rates in line with where the actual market price for borrowing and investing money (interest rates) has been for 12 months already i.e.5%. The banks’ combined cost of funds will not change due to the OCR increasing, their funding costs are already established at 5% to 6% and will remain there through this year. The OCR increases this year will have no impact on the domestic economy through investor/borrow/consumer behavioural changes, as their market interest rates will not change much.
The only thing a fast and furious OCR lift from June/July onwards will do is to attract speculative buyers of Kiwi dollars in the FX markets as the “NZ monetary tightening” headlines hit the global newswires. So the Kiwi dollar appreciates on its own accord in the second half of the year and the clobbered exporters wonder why the RBNZ allowed this monetary policy sloppiness to occur. The RBNZ’s problem and predicament goes back to early 2009 when they slashed the OCR to 2.50% and then introduced the Core Funding Ratio regulation on the banks. The RBNZ should never have allowed the OCR to get so far below true market interest rate levels. Yet again, the export sector is likely to pay the price for this monetary policy boo-boo.
US bond yields still pushing upwards
Stronger US economic data over coming months looks set to push US 10 year Treasury Bond yeilds up through the resistance line at 3.50%. A decisive break upwards should see a return to 4.00% relatively quickly. Consequently, NZ 10-year swap interest rates are forecast to increase from the current 5.40% level to above 6.00%. The three to 10 year term swaps rates will also be dragged upwards accrodingly.
NEW ZEALAND DOLLAR MARKET COMMENTARY
Has the luck finally run out for the lucky country (and currency)?
The Kiwi dollar appears to have temporarily de-linked from EUR/USD movements. The Kiwi did not move down too much against the USD when the EUR/USD rate dipped below $1.3000 in December, and now the Euro has surprisingly rebounded to $1.3600 the Kiwi has not exactly roared higher either. To me, the recent EUR strength on the back of some miss-placed Euro-babble on inflation/monetary tightening will not last long. The ECB will be looking straight-through any inflation coming from higher food/commodity prices and not raising their interest rates anytime soon. They should be cutting their interest rates to get their consumers spending again. They should observe Bernanke’s seemingly successful monetary stimulus measures in the US as the best policy response.
If “risk-off” settings in global investment markets coincide with stronger US economic data (GDP numbers this week) and negative news out of Europe over coming weeks, the NZD/USD rate should follow the EUR/USD rate lower. We are still forecasting the EUR/USD rate to drop to $1.2500 and $1.2000 this year. Outside China/commodity price/Australian economy influences, the NZD/USD rate appears likely to move lower over the first half of 2011 to 0.7000 and below, and then reverse back upwards over the second half of 2011 as the RBNZ lift the OCR.
The wild-card variable for the Kiwi dollar this year is Chinese inflation, economic growth and their monetary policy response. If the PBOC over-reacts to the rising inflation and tightens monetary policy too hard, hard commodity prices will fall sharply resulting in a stronger USD and much weaker AUD exchange rate. The Kiwi would follow the AUD downwards in such a scenario; however to a lesser extent as NZ interest rates will be increasing over the second half and Aussie interest rates will be static. The AUD rate against the USD has traded above 1.0000 on three separate occasions over recent months and has not been able to hold above the parity level each time.
I suspect that global currency players are not comfortable at being long AUD’s at these high levels if there is a risk of a sudden shift down in hard commodity prices due to the China effect. Perhaps as the Queensland floods and the loss of the Ashes in cricket tell us, the good luck has all but run out on the lucky country and their currency as well.
The RBA are “on hold” with monetary policy adjustments and will also be “looking-through” short-term/food related inflation increases and forecasting lower GDP growth this year for the Australian economy. Lower commodity prices may also slowdown the massive capital/investment inflows out of Asia into Australia over recent years that have pushed the AUD up. High consumer confidence is starting to wane in Australia and their spectacular jobs growth numbers seen last year may also be much less impressive this year. It all adds to a less certain Australian economic outlook and the “one-way” bet on the AUD currency last year as they increased interest rates looks far less assured this year.
The offshore drivers (EUR and AUD) will dominate NZD/USD direction over the first six months of 2011; however increasing NZ interest rates over the second half will yet again make the NZ dollar a reasonable trade for the currency markets, reversing the first half losses.