It was pretty obvious the NZ dollar was set to fall from its recent highs, and as I said in my January newsletter, “The question now seems to be how far will the New Zealand dollar drop and how fast?”
Well it’s now at about US61 cents which is 17% lower than its post float high of US73.65 cents a year ago. Most of the drop has taken place since January – from US71 to US61 cents.
The Fed’s increase in the cash rate in the U.S. to 4.75% (two days after the announcement, the Kiwi fell to under US60 cents for the first time since May 2004), talk of interest rate rises in Japan, the impending maturity of the Japanese Uridashi Bonds here, and the NZ current account deficit of $13.7 billion (now 8.9% of GDP), have all finally hit home.
Of course the Aussie dollar hasn’t fared much better. Since January it’s dropped 6 cents from US76 to US70 as rising U.S. interest rates reduce the appeal to overseas investors of holding Australian financial assets. And Australia is enjoying a commodity export boom!
This simply confirms the fact that it’s capital movements and not exports that determine the exchange rate. In fact around the middle of March, U.S. investment bank Lehman Brothers recommended selling the dollar block currencies of Australia, Canada and New Zealand as central banks in those currencies moved towards cutting or keeping interest rates unchanged. The prospect of stable or lower interest rates made it “much less attractive to be invested in those currencies”.
So what will be the effects of a falling dollar?
• Clearly this is of benefit to exporters and especially the rural sector. This will be helped by increasing demand as global growth is still strong at around 4%. Beef, lamb, wool and fruit farmers should feel the effect first as about 90% of this production is exported. Dairy farmers are effectively “hedged” through Fonterra. This is just as well as world prices for our commodity exports have dropped for the 10th consecutive month. They’re now back to where they were in mid 2004.
• According to Westpac’s economists, their analysis “suggests exchange rate movements feed through quickly to import prices, to the tune of about 75%, but pass through to the Consumer Price Index takes up to a year and is much more muted, around 10%”. Their forecasts suggest the current fall in the NZ dollar would add up to 1.2% to the CPI early next year as importers and retailers absorb increases through the margin, but:-
• Petrol prices. These are up over 15% since the start of the year and have an immediate impact on consumer spending and squeeze margins. As the recent increases seem to be more currency driven than oil price driven, this should have little impact on growth (more exports offset less domestic spending). But the reality of seeing the increased cost of filling the car does increase inflation expectations and make consumers more wary. The National Bank’s economists calculate headline inflation would hit 3.5% once the recent round of petrol price increases are added to the RBNZ’s own inflation forecasts.
• Increased confidence in listed exporting companies may be reflected in their share price – although other economic factors will overshadow movements in the market itself. Right now the market’s in a bull run with the NZX 50 up 8% in March alone.
• Travel and luxury items. It may be anecdotal evidence, but much of what I’ve seen suggests people have been making the most of the high dollar to travel and buy imported items before the dollar’s inevitable fall. Expect this rush to drop off.
• Resurgence of offshore interest in selected property. New Zealand still has the scarcity value of coastal, lake and “tourist” properties like Queenstown and Wanaka sought after by offshore buyers. These are now starting to look cheap again.
Most commentators see a continuing drop in the NZ dollar to the US 50 – 60 cent range. Some see it over sold and a short recovery to the mid 60s over the next couple of months. But recent experience would show any bull run is short lived and I’d be surprised if it went above US 62 cents.
In any event given the dollar’s decline and the continuing strength of the housing market, don’t expect the RBNZ to drop interest rates now. With a booming sharemarket and unemployment at 3.6% you’d find it hard to say the country’s in recession and inflation is under control.
It’s interesting to see what’s happening with interest rates now.
I don’t think there’s any question the floating rate has peaked. The chance of an increase in the Official Cash Rate – which drives the 90 day bank bill yield which drives the floating housing rate – is remote. However, for the reasons given above, I can’t see any immediate drop in the OCR and hence floating rates.
Residential fixed rates are mainly set by the wholesale market swap rate - of the same term - which in turn is influenced by offshore medium to long term interest rates. There are numerous other factors which influence the swap rate - including supply and demand for swaps, maturity of Uridashis and changes in capital inflows to the U.S. These are notoriously difficult to predict.
Right now fixed rates seem to be the result of a low demand for swaps. People are saying, “floating rates have peaked, will come down but I don’t know when, so let’s not fix”. So there’s little demand for fixed rate loans and the rates keep coming off.
How long this will last who knows. At some stage the $42 billion of fixed rate loans maturing this year in New Zealand will need to be refinanced. That’s about 40% of outstanding fixed rate loans. These borrowers have enjoyed an average rate of around 7.3%.
So what are current (residential) rates and how do we compare with our Aussie neighbours? Last Tuesday the Australian Reserve Bank held the cash rate at 5.50 % for the thirteenth time in a row. But more and more commentators there are picking rates will rise later this year. Following is a comparison of Westpac’s (standard) residential rates here and across the Tasman.
Variable rate – NZ 9.55% and Australia 7.32% - difference 2.23%
1 year – 8.20% and 6.89% - difference 1.31%
2 year – 7.70% and 6.79% - difference 0.91%
3 year – 7.60% and 6.75% - difference 0.85%
4 year – 7.60% and 6.89% - difference 0.71%
Other banks and non banks vary slightly but you can see the point – it’s the high OCR here that’s keeping our floating rate up. And there’s not that much difference between the fixed rates.
Right now you’d have to say don’t expect much change in floating rates this year. But long term rates are rising offshore - and fixed rates here must eventually rise.
Cheers
JP
John Paine B.Sc. Dip BIA
Global Pacific Corporation Limited
P O Box 3229, Auckland, New Zealand
Phone 64 9 303 3700, Fax 64 9 303 3031
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Email john.paine@globalpacific.co.nz
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