Who would want to be in Alan Bollard’s shoes right now? Damned if he does and damned if he doesn’t. As many others have stated over the last three years, implementing the emergency monetary stimulus in 2009 was the easy part (dropping the OCR to 2.50%), unwinding the stimulus was always going to be the hard part. Based on GDP growth and inflation starting points today being substantially above all RBNZ expectations, he really should be shoving interest rates up now.
The inflation risks and inflation expectations are elevated sufficiently over the next 12-18 months to justify a monetary policy setting on the slightly tighter side of neutral, not extremely loose as they currently stand. However, Alan cannot raise official interest rates immediately as it will only shunt the Kiwi dollar even higher than its current 30-year highs of 0.8500. Yet again, he is between a rock and a hard place with monetary policy management. He could argue that the FX markets have already fully priced-in significant interest rate increases and thus if he did lift rates the Kiwi would not necessarily go any higher. That is a pretty bold assumption and not one Alan would want to risk at this point of time. The RBNZ have been heavily criticised in the past for damaging the export/productive sector too much to combat inflation that is supply-side sourced rather than demand related. He will be reluctant to go there.
So, the RBNZ has a real dilemma here, interest rates are too low for an economy growing reasonably well and for an Auckland housing market starting to reflect a shortage of new houses being built in recent years and a shortage of existing housing stock being made available for sale. It seems the RBNZ will wait for the June quarter’s GDP figures, due out in late September, before being convinced about the sustainability of the stronger economic growth. Therefore, the first increase could well be the 27 October OCR review date. It is too late of course; however he will be hoping that USD strength and global commodity price weakness between now and then will take the heat out of the NZD/USD exchange rate and bring it down. An increase in interest rates when the Kiwi dollar is at 0.7500, rather than 0.8500, should be more palatable for the export economy.
The high currency value at 0.8500 offers other challenges to the RBNZ. Most economists will now be forecasting annual inflation to be above 3.00% in 12 months time, not at a comfortable 2.00% mid-point the RBNZ have been forecasting. However, how much will the high Kiwi dollar bring down the prices of imported consumer items? Likewise, how much should +4.50% GDP growth forecasts for 2012 be lowered to cater for USD exporters being non competitiveness above 0.8000? Tricky questions, that I am sure are occupying the minds of RBNZ economists right now.
These will not be the RBNZ’s only worries at this time. If they were not suspicious as to the reliability of their model for the NZ economy before the GDP shocker, they will be seriously worried after it. The +0.8% GDP growth was not due to any one-off factors, it was almost across all industry sectors. Forestry and construction were the exceptions; however construction will certainly be expanding from here with the Christchurch re-build. Similar to the 1993 and 2003 recoveries out of recession for the NZ economy, the RBNZ on both those previous occasions under-estimated the speed and strength of the export-led growth and left tightening of policy too late.
It may be argued that the circumstances are different today, however not dramatically different. As has been stated many times in this column over the past 12 months, if you watch the retail/housing indicators as a lead for economic growth, you are watching the wrong things.
NEW ZEALAND DOLLAR MARKET COMMENTARY
NZD buyers “creaming it” for now, however it might curdle if they leave it too long!
The NZ dollar continues its spectacular rise as our economic performance and outlook just looks so much better than alternatives in the eyes of foreign investors and currency speculators. Last week’s GDP growth result of a +0.8% increase in the March quarter confirming that the export boom from super high commodity prices has been underway for nine months already, however the economic expansion has largely gone on below the radar of most. The NZ dollar has strengthened again on the back of the strong growth numbers. In particular, the Kiwi dollar has jumped another cent higher against the AUD, from 0.7850 to 0.7950.
Despite the resources boom, the overall Australian economy is starting to struggle in the face of their high AUD value (non-mining exports) and weak retail spending. The latest talk in Australian financial markets is that the Reserve Bank of Australia’s next change with official interest rates may well be downwards. The AUD/USD exchange rate has been trading up and down the 1.0500 to 1.0800 range, however luck appears to be running out for the lucky country and global investors now seem to be reluctant buyers of AUD’s at the higher levels. T
he AUD/USD exchange rate also tracks the JPY/USD rate closely. The Japanese Yen has strengthened to below 80.00 against the USD on investors holding off from buying USD’s until the US Government debt ceiling problem in resolved. The foreign exchange markets are very wary of Bank of Japan intervention, selling the Yen and sending the rate higher to 85.00 and 90.00. If this did occur, the AUD would follow and be sold below 1.0000 to the USD.
The NZD has made impressive gains against all the currencies, with all cross-rates increasing over recent weeks. Such across the board gains tells us that this is specific and separate NZD strength. The buyers of NZD’s continue to be mostly Asian-sourced, sovereign wealth funds and currency momentum traders. They like the positive NZ economic story from our agriculture export prices being at 30-year highs. Last week’s extraordinary GDP numbers confirming their perhaps superior understanding of what drives the NZ economy compared to local mainstream economists who ended up forecasting a 0.4% GDP increase, however only a few months ago most of whom were projecting a negative number!
The foreign investor confidence in the NZ economy and currency is largely based on the price of our major export, wholemilk powder (“WMP”). The globally traded WMP prices were recording sharp gains up until March of this year. However, over recent months, as evidenced in the fortnightly Fonterra GDT on-line auctions, the prices have corrected downwards rather dramatically. In their milksolids payout forecast to dairy farmers for the next year, Fonterra appears confidence that WMP prices will hold up at the USD3,600 per tonne levels. However, there is no guarantee about that and all commodity prices do not have the same invincibility about them that they enjoyed a few months back. Global growth has been revised downwards and eventually US interest rates will increase, both of which are negative for commodity prices. If the NZ dollar has one vulnerability to a sell-off it would have to be WMP prices continuing to slide downwards. Many of the Asian investors who have bought into the Kiwi dollar have done so on the back of the positive dairy story. If falling WMP prices start to undermine the original rationale for buying and holding the Kiwi, the currency’s attractiveness will rapidly wane.
In the short-term, a resolution of the US debt ceiling well before the 2 August deadline date should allow for a recovery in the USD value against the EUR and JPY. The soft patch in US economic data over recent months has also been partially caused by US corporations waiting- off on investment decisions until they see that their own Government can get their financial house in order. Compromise is required from both political sides to end the current impasse and the pressure coming from the credit rating agencies and Ben Bernanke at the Federal Reserve. A USD exchange rate value against the Euro travelling below $1.4000 (currently $1.4100) towards $1.3500 should bring the NZD back from 0.8500.