Exchange rate guessing game

OPINION: Last week the New Zealand dollar hit a 10-year low against the aussie dollar near 76 cents and a 30-year high against the British pound near 47 pence, writes Tony Alexander this week.

Why the divergent movements when we are used to talking about the kiwi dollar being either strong (against everything) or weak (against everything)? The answer is that there are some strong forces at work affecting economies in different ways around the world.

In Britain, the government's finances are bad and getting worse at a seemingly rapid pace. There are worries about all governments with large deficits and big debts at the moment because of the extreme problems affecting Greece. Although there are countries in bigger holes financially, Greece's problem is that the extent of the debt mountain was hidden from public view and this act of lying to investors in particular has created extreme scepticism about the Greek government.

But more than that when it comes to Britain, the economic data have been tending to surprise on the bad side and there is talk that the Bank of England may have to increase its money-printing activities. Printing money is a sure-fire way to devalue the worth of it and in foreign exchange terms that means depreciation.

Plus, Britain is losing some of its lustre as a financial centre as the government cracks down on the banks, and some companies are shifting their headquarters elsewhere.

Across the ditch things could not be more different. The Australian economy grew 2.7 per cent last year, the unemployment rate has dropped sharply with jobs growth in recent months far greater than anticipated. House building and house prices are rising, consumers are spending in the stores, net migration is near record levels, and there is a new mineral sector boom. Plus infrastructure spending is rising strongly.

Whereas the Bank of England is unlikely to raise its cash rate from the current 0.5 per cent until next year the Reserve Bank of Australia has already increased its cash rate by 1 per cent to 4 per cent. We think the rate will reach 4.75 per cent by the end of the year.

In New Zealand we sit in the middle. Our economy is out of recession but not soaring. Government accounts are tremendously superior to those in Britain but not as good as Australia's. The Reserve Bank is not easing monetary policy any longer but neither is it tightening.

The question many people want answered of course is where do these exchange rates go from here? If I knew I wouldn't be sitting in a hotel room at 10pm in Auckland typing this out, would I? Exchange rates cannot be reasonably predicted. But everyone wants a view so here is one.

A lot of the bad news is now factored in for Britain. While there is a clear risk the pound depreciates further, if I had to take a currency position now and close it out in a year or two's time it would be one of selling kiwi dollars and buying pounds. For Australia a key dynamic is that the interest rate raising cycle has started before ours. We may kick off in June.

That means at some point the interest rate differential between our countries will shrink and we will inevitably have our cash rate once again above theirs rather than being in the extremely unusual current position of sitting 1.5 per cent lower. I therefore would buy kiwis and sell aussies if I had to take a one or two-year currency position. Heck, maybe the best bet for true punters is to sell aussie dollars and buy pounds to hold for the next two years.

If you do that I wish you good luck because along the way you will need it.

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

- © Fairfax NZ News

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