Currency looks set to hit US80c

OPINION: Many factors cause the New Zealand dollar to go up a long way against other currencies such as the Japanese yen and United States dollar, and then go back down the other way, writes Tony Alexander this week.

 One factor is commodity prices.

We are known as a commodity currency. When our export prices rise – as we have seen this year with wholemilk powder prices up 90 per cent and our overall export prices ahead 26 per cent since February – the New Zealand dollar rises on expectations of an improving trade balance. The NZD this year has gone from US50 cents in February to US76c recently.

When these prices fall, as they did 34 per cent between July last year and February, the NZD falls – from US76c to US50c for the period.

This commodity price factor has dominated the impact of interest rates because although between July last year and February the Reserve Bank's official cash rate fell from 8.25 per cent to 3.5 per cent, further cuts to 2.5 per cent by April did not prevent the NZD from soaring by US26c.

But by and large we are known as a high-yielding currency.

This arises because we are so determined to buy all we see advertised that we are prepared to pay interest rates to borrow money at levels people overseas would not contemplate.

If we householders actually saved instead of spending 13 per cent more than we earn then our interest rates would be lower on average, the currency would be lower on average, and our export sector would be bigger. Our currency would probably also be less volatile because we would attract less buying from investors pursuing the carry trade. This involves borrowing in a low interest rate currency, selling it, then investing in a high interest rate currency. This is one factor pushing the USD down currently and applying some upward pressure to the NZD – though we don't know how much.

Some commentators suggest we should try to stop this trade by taxing such flows. Brazil has introduced a tax on investments from offshore while others propose something called a Tobin Tax. This involves taxing every financial transaction. Given that we need the money of foreigners to fund our way of life and because we are desperately keen to keep borrowing, there is little doubt that we householders would probably be willing to compensate foreign investors for this tax by offering them even higher interest rates.

The NZD is also known as a peripheral currency. We are in the monetary wop wops and when investors feel happy about the world they see around them they will send more funds our way to take advantage of the high interest rates we offer to entice them in. But when they are scared about what they see they want their funds close to home. It was this strong risk aversion factor which mainly accounts for the NZD's sharp decline last year. And it is the same factor which explains the bulk of the rise this year.

The view we have been giving since at least May, and which we maintain now, is that unless something comes along to aggressively dent growing confidence in a recovering global economy, the NZ dollar will drift higher. It will also drift higher if our interest rates look like they will be pushed higher by our central bank before they start rising in Japan and the US in particular. Such a development is near guaranteed given comments from both countries and our central bank's indication of rate rises sometime in the second half of next year.

And finally, the NZD will drift higher if our export commodity prices keep rising. They are in fact still creeping higher, therefore all up it remains reasonable to expect the NZD will drift up and eventually reach US80c – sometime before the end of next year. Tony Alexander is chief economist of the Bank of New Zealand (BNZ).

» Tony Alexander is the chief economist for the Bank of New Zealand.

- © Fairfax NZ News

Newest First

Oldest First