New Zealand Dollar Cornered

The US economic contagion seems to be finding its way far and wide. New Zealand’s economy seems to have been hit worse than others and it may already be in recession. Rising inflationary pressures resulting from a increasing in food and oil prices have created a tight position for the Reserve Bank of New Zealand (RBNZ), which was planning an interest rate cut to provide a monetary boost to the sagging economy.

As per latest economic results, the Kiwi economy has started displaying signs of sustained weakness along with mounting inflationary pressures. To top it all, New Zealand already has one of the highest interest rates in the developed world. This makes the situation a tight fix for the RBNZ and Kiwi land may be in for a tough economic tread ahead.

The Kiwi economy reportedly contracted 0.3% in real terms in the first quarter of 2008 and that too on the back of the previous quarter’s abysmal 0.8% growth. These estimates were based on an output basis, with the results on expenditure basis being even poorer. In expenditure terms, real GDP contracted 0.6% on the back of a 0.5% gain in the previous quarter. The contraction in the GDP was led by a decline in agricultural output as well as subdued construction and manufacturing activities. While, the services sector displayed a positive trend, the growth decelerated to 0.3% down from 0.9% in the previous quarter. As may be expected, decline in economic activity leaves less money with people to spend, which seems to have led to fall in consumption by 0.4%. This is reportedly the first such contraction since 2004. Business confidence also seems to have taken a beating. Business investment contracted nearly 1.2% though investment in plant and machinery was up 5.9%. The global squeeze in demand also seems to have hit Kiwi exports, which contracted nearly 1.8% in the first quarter of 2008.

Well, RBNZ could have thought a strategy out of the squeeze by lowering interest rates. However, the RBNZ is expecting inflation to creep up to 4.7% from around the 3.5% rate at present. What makes matters worse for the economy is that the interest rates are perched at a high of 8.25%. This makes it very difficult for RBNZ to raise rates to fight inflation. At the same time RBNZ may not be in a position to lower interest rates as it needs to ward off looming inflationary pressures. It appears that the combination of the recessionary tendency and high interest rates may force the RBNZ to lower rates in subsequent quarters if the inflationary tendency remains under check. The RBNZ governor, Alan Bollard, has reportedly stated that he is likely to cut cash rates from the prevalent 8.25% as the economy slows further. This would clearly keep the Kiwi dollar weak and may lead to some erosion in its value as well.

Bloomberg has termed the Kiwi dollar as the second worst performer in the last three months, after the Korean Won, from the 16 major currencies that it monitors.

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