Lower US dollar reflects loss of momentum

Washington (Jun 22)  What a difference a year makes. In June last year, the  New Zealand  economy was really picking up steam. The RBNZ had just pushed through three quick-fire Official Cash Rate (OCR) increases in a row. This had taken the OCR from 2.5 per cent, where it had been sitting since the  Christchurch  earthquake in 2011, to 3.25 per cent. The RBNZ increased rates one more time to 3.50 per cent, and gave the market clear notice that further interest rate rises would come in 2015.

In stark contrast, the Federal Reserve in  the United States  was still printing money at a pace of  US$35 billion  each month, even though this was well down from the peak of  US$85 billion  . There was no sign of the Fed increasing interest rates from zero, and many people thought the money printing would carry on for another few years, at least.

The NZ dollar was trading at 87c against the out-of-favour US dollar and people were talking up the prospect of it heading into the 90s.

Currencies tend to act like a country’s share price, falling to reflect a worsening outlook and rising when things start to look brighter.

This generally goes hand-in-hand with higher demand, which puts upward pressure on prices and inflation, then ultimately on interest rates as central banks are forced to respond to these moves.

Today, the US has well and truly wrapped up its money-printing life-support programme and is close to raising interest rates for the first time in nine years. Inflation remains low and the recovery has been patchy, but things are definitely improving with the labour market in particular making solid progress.

 New Zealand  , on the other hand, is losing momentum. After being the only central bank in the developed world to raise interest rates last year, the RBNZ might soon go close to reversing all four of the OCR hikes we saw last year.

Consequently, our “share price” has fallen against its American counterpart (as well as others) to reflect these shifting fortunes. At 69c it is down 22 per cent from last year’s high and is back at levels not seen in five years. It could certainly go lower, especially if the current speculation of two to three more rate cuts becomes a reality.

There is a strong relationship between the currency and global dairy prices and for comparison, when dairy prices were last at current levels the NZ dollar was in a range of 60c-65c.

These developments aren’t all bad. As far as the US goes, we should be encouraged that the world’s biggest economy is strong enough to start thinking about higher interest rates. The economic life-support that the US has been on for some years has been artificial, so genuine signs of strength are a huge positive.

There are two sides to the story for us as well. Dairy prices have halved over the last two years but meat, wool, horticulture and seafood prices are all up about 8 per cent on average. The sharply lower currency will provide a tailwind to all these commodities, as well as other exporters and the tourism sector.

Lower interest rates will help borrowers, and hopefully give housing markets in the regions a boost when combined with slightly looser mortgage restrictions. Investors who have taken advantage of the high NZ dollar in recent years to expand their horizons will also be sitting on very strong returns. The savers who have been waiting patiently for more attractive interest rates rises won’t be quite so happy, and neither will online shoppers and overseas travellers. The latter might still have some hope though, with  Greece  still a chance of being thrown out of the euro and reverting to the old drachma.

Source: TheNewZealandHerald