Today we have the inverse of that situation developing with the RBNZ running the risk of having monetary policy “too loose, for too long”. The danger is that inflationary risks build up in a stronger growing economy this year, however the RBNZ delay monetary policy adjustments until it is too late to be effective. The markets and the RBNZ are currently looking back at the flat economy over the second half of 2010 and concluding that there is low risk of inflationary pressures in 2011/2012 and thus monetary policy can remain “very loose” for much longer into 2011. Mr Bollard has clearly stated that he wants to see conclusive and hard statistical evidence of growth this year before moving the OCR up. My ongoing contention is that by the time he has the evidence and proof it will already be too late to pre-empt inflationary pressures. The result is that the RBNZ find themselves behind the 8-ball in controlling inflation and have to push short-term interest rates up more rapidly and in larger steps than otherwise could have been the case. The outcome of that situation is a sharply rising Kiwi dollar value and further damage to the all-important export sector (yet again!). Monetary policy errors have real economic consequences and lurching from one extreme to another has caused problems in the past. The RBNZ need to avoid being behind the 8-ball later this year and the early-March Monetary Policy Statement coming up is an opportunity for the RBNZ to articulate the risks of leaving monetary policy “too loose for too long”.

 

The RBNZ’s pre-occupation with the residential property markets as the key driver of the NZ economy (thus monetary policy settings) is also a dangerous in-built  bias. If they are waiting to see some life in the housing market this year before adjusting the OCR upwards, they will be looking at the wrong lead indicator. The critical lead indicator to stronger GDP growth this year will be when and how farmers spend their much increased incomes form the record high beef, lamb and diary prices. The RBNZ are firmly of the view that all the extra income will go to repaying debt (particularly in the highly indebted parts of the dairy sector). The majority of farmers will however be reinvesting the additional cash in their businesses with fertiliser, fencing, contractors and machinery. That increased spending has an enormous impact on provincial New Zealand and eventually feeds into the cities. The high prices are a big incentive to lift output off the land. As dairy land prices recover back up and farm balance sheets improve the bank lenders will relax somewhat.

 

 

 

Plenty of talk over recent weeks about a double-dip recession in the NZ economy over the second half of 2010 and potential credit rating downgrades for the Aussie banks – factors that you would have thought would push the NZD lower in the FX markets. Usual conventional wisdom is that “interest rates lower for longer” in NZ is negative for the Kiwi. However these days the NZD/USD is not been driven by interest rate differentials, if we were, the Kiwi would be trading below 0.7000. The movements of the USD against the Euro, Aussie $ and the Yen continue as the dominating influence over the NZD/USD rate, not domestic economic conditions. Being categorised as a commodity currency in an environment of high hard and soft commodities helps keep the Kiwi up as well!

 

The continuing international macro themes of stronger US economic data, talk of interest rate increases in Europe (unlikely in my view) and tighter monetary policy in China not yet correcting commodity prices downwards are resulting in a whip-saw price action for the USD value against major currencies on global FX markets. The EUR/USD rate back at $1.3700 is unlikely to be sustainable, particularly if there is a rush to safe haven currencies (i.e. the USD) as Middle-East political tensions escalate. Therefore, the NZD foray back above 0.7600 is viewed as being very temporary. To get NZD/USD rates below 0.7500 however will require Euro weakness well below $1.3500 against the USD.

 

The AUD/USD rate is back well above $1.0000 for the fifth time in recent months, the unrelenting gains in hard commodity prices and BHP’s profits attracting AUD buyers. There is a swag of Australian economic data coming out over the next two weeks that appears as if the weaker than expected data could disappoint the markets. On the basis of these data releases and a stronger USD against the EUR, the fifth AUD climb above $1.0000 to the USD should result in the same outcome as all the earlier attempts - a reversal back below $1.0000.