Inflation figures released this morning (+0.8% for the quarter and +4.5% for the year) confirm some of the challenges ahead this year for households, business firms and our managers of monetary policy, the RBNZ.
There is no doubt that the elevated financial pressures on your average household from sharply higher fuel, transport and food prices is going to lead to higher wage increase claims this year.
Some industries are in a position to pay higher wages; other industries such as the retail sector have compressed profit margins already and will resist trade union demands. All this adds up to these supply-side price increases having a potentially higher risk of feeding into wider/general inflation later on.
For this reason the RBNZ are too light on their current 2012 inflation forecasts and when they realise they have to increase these to nearer 3.00% they really have to return monetary policy settings to “neutral” (i.e. 4.50% OCR) with some urgency in early 2012. The moneymarkets and swaps markets are already starting to price in this scenario. Had the Christchurch 22 February earthquake not happened, we would have been witnessing embarrassing U-turns by many gurus as to their timing of OCR increases in 2011. The markets would have shifted from October increases to June increases about now in response to the higher inflation outlook. It is not just higher food and petrol prices pushing inflation higher than expected this year, add in electricity, gas, insurance premiums, building costs and the perennial local Government rates increases.
The RBNZ do not just look at the headline and core inflation forecasts in isolation. The overall demand and strength of the economy is assessed and analysed constantly as lead indicators that raise and lower the risks around the inflation forecast. Standing in January 2012, Alan Bollard will potentially be looking into 2012 with an inflation forecast above his 3.00% limit and a GDP growth forecast above +4.00%. All this is predicated on our export commodity prices staying up near their record high levels.
According to the recent RBNZ research paper on commodity price increases (as mentioned in Mr Bollard’s speech to Ashburton farmers last week) our commodity prices are set to stay high due to global supply/demand imbalances. Unfortunately, that research paper omitted two additional key determinants of global commodity prices; artificially low US interest rates rendering holding costs of virtually zero and the weight of money from pensions/superannuation managed funds being allocated to commodities as a separate asset class over recent years. If commodity prices correct downwards due to increasing US interest rates, the pressure comes off food price inflation and NZ GDP growth will not be as impressive in 2012. Hopefully the RBNZ are comprehending and monitoring some of these global inter-relationships that directly impact on the NZ economy.
The NZD/USD exchange rate almost at 0.8000 will reduce retail selling prices on imported product, however a lower NZD/USD rate due to an expected USD recovery against all currencies over coming months could change that off-setting factor again.
The pressure is certainly on the RBNZ as they deal with the extraordinary circumstances of the earthquake and booming agriculture export prices on the economy. Corporate borrowers need to be looking forward and taking pre-emptive interest rate hedging action today for what their hedging policies will be requiring them to do in nine to 12 months hence. The two to five year fixed rate swap rates are likely to be over 1.00% higher by the end of the year.
NEW ZEALAND DOLLAR MARKET COMMENTARY
The 0.8000 NZD/USD level unlikely to hold for very long
The Kiwi had another peak at 0.8000 this morning, however a slightly lower than expected March quarter’s CPI increase of +0.8% has caused some short-term profit taking down to 0.5950. There is always a debate as to the nature of the Kiwi dollar buying that has caused the dramatic spiral higher from below 0.7200 just four short weeks ago.
How much of the NZD buying is real permanent capital inflows into New Zealand and how much is speculative, hyped-up hot money chasing a short-term profit is never really measured and known. What we do know is that over recent weeks the increased volumes of NZ Government bonds sold to foreign investors and earthquake reinsurance payments have caused heavy NZD buying. These are two permanent capital inflows that will not reverse next week. The borrowing activities of NZ banks in foreign debt markets is not a cause of NZD buying as the banks simultaneously sell the NZD forward to hedge their USD borrowing and create NZD liabilities. If the debt issuance and reinsurance flows reduce from current high volumes the support for the NZD will reduce.
Outside these capital-flow influences, is the speculative element that latched onto Alan Bollard’s comments last week that the much higher agricultural commodity prices are very positive for the NZ economy and currency going forward. Whilst the Governor’s comments were correct in one sense, his comments were interpreted as very bullish for the Kiwi and it was sent another two cents higher. The Governor’s musings are in sharp contrast to his deliberate jawboning down of the currency just a few months ago. Non-commodity exporters will not be too pleased at this seemingly reversal in currency opinion from the head of the central bank.
The NZD/USD exchange rate has never been able to sustain rates above 0.8000 when is has been here before. I do not think it will hold onto its gains this time either, due to two expected currency market changes over coming weeks:-
§ The EUR/USD reversing from $1.4400 to below $1.4000 following a more upbeat US Federal Reserve next week and continuing deterioration in European sovereign debt markets.
§ The AUD correcting down from $1.0550 against the USD after its “too far, too fast” appreciation over recent weeks. Tighter monetary policy in China must bring global commodity prices off their highs soon, I would have thought.
USD importers have an opportunity to hedge much higher proportions of future USD payments at these levels, particularly those with “filter-test” triggers in their hedging policies (15% above the 7-year average rate = 0.7950) requiring longer-term hedging beyond 12 months.
Importers need to act quickly as wide-scale profit-taking in the NZD (i.e. NZD selling) cannot be very far away.
Is intervention selling in the NZ dollar forex market likely from the RBNZ as the Kiwi soars to 0.8000? I do not think so, the pre-requisites do not appear to be there and the TWI value at 69.0 is a long way below the 74.0 level where the RBNZ intervened in 2007. Even though the NZD is at cyclical highs against the USD at 0.8000, the NZD/AUD cross-rate at 0.7500 is at cyclical lows. In 2007 the NZD/AUD cross-rate was above 0.9000.