The Kiwi was one of the winners among the major currencies in 2016, but the monetary policy changes and economic conditions didn’t exactly fit the bill.
To understand New Zealand dollar price action and the monetary policy moves by the Reserve Bank of New Zealand (RBNZ), let’s first dig into a few economic data points.
After the Financial Crisis of 2008, we can see that the New Zealand economy has grown solidly: +2.00% annualized on average since 2010, with the latest round of gains attributed to “strong inward migration, construction activity, tourism, and accommodative monetary policy,” according to the RBNZ in their August monetary policy statement.
But inflation, on the other hand, has been down in the dumps with CPI growing less than 0.50% y/y in the recent quarter, and PPI–despite big improvements over the past year–has spent the majority of the last three years in the negative.
Why is Inflation so Weak?!
According to the RBNZ in their June Statement of Intent, weak inflation conditions were likely due to a mix of many factors throughout the year, including a fall in oil prices, spare capacity in the global economy, “stronger-than-expected growth in labor supply” dampening wages and consumer spending, etc.
But the main driver is likely from the low global inflation, “causing negative inflation in the tradables sector” as stated by the RBNZ in their September meeting. In other words, global inflation has been falling and taking down broad inflation conditions in New Zealand with it.
And finally, the RBNZ cited continued Kiwi strength as a hindrance to inflation growth. A rising currency can put pressure on inflation by increasing demand / reducing supply, which would likely amplify the effects of weak global inflation.
The Kiwi dollar has certainly defied the RBNZ’s expectations of pulling back in 2016 to make the fight against low inflation much more difficult. Taking a look at the New Zealand Dollar Trade Weighted Index below, making gains throughout 2016:
In the chart above, we can see the New Zealand dollar make steady gains after that very early 2016 fall in broad risk sentiment (China fears and falling oil prices). RBNZ Governor Wheeler cited “Weak global conditions and low interest rates relative to New Zealand” as the reasons for the Kiwi’s strength in the August monetary policy statement. It makes sense, right?
Who would want to invest in an asset with a relatively high interest rate and linked to a solidly growing economy like New Zealand? Everyone we think! So, that’s why we agree with the Governor on why the Kiwi barely saw any speed bumps on its way higher.
So to fulfill its mandate of price stability and try to hit its target 1%-3% inflation range for the economy, the Reserve Bank of New Zealand issued three interest rate cuts to help spark inflation: a cut to 2.25% from 2.50% at the March meeting, a cut to 2.00% at the August meeting, and finally down to 1.75% in the November meeting.
These weren’t easy decisions for the RBNZ to make given that they didn’t want to overheat an already robust economy, especially what may be an already overheating housing market:
House Prices continued to accelerate higher in 2016, despite an increasing issuance of building permits in an effort to drive down prices with an increased supply of homes. Continued rate cuts may ignite further housing price increases, but fortunately, the RBNZ revised the investor Loan-to-valuation ratio restrictions to limit home buying.
With a little bit more wiggle room in the housing situation, it’s not crazy to think we may get a few more rate cuts from the RBNZ in 2017.
Even with the three cuts in 2016, the current RBNZ interest rate is still well above its major currency peers, and one more 0.25% cut would only bring the overnight cash rate inline with Australia’s at 1.50%–still high against the rest of the majors.
If they really want to slam the currency lower, they might have to slash big time. If they don’t cut, buying support may likely persist in 2017.
Continued economic growth could be a limiting factor for additional rate cuts, so be on the lookout for further GDP gains, as well as any additional gains in the housing sector.
Also, the New Zealand dollar does react with broad global risk sentiment being that it is a relatively high-yielding currency, so a drop to risk-averse sentiment could drop the Kiwi as well, relieving the need for additional rate cuts from the central bank.
Last but not least, keep an eye on Global Dairy prices. Dairy is the largest export market for New Zealand so it’s a constant concern for the RBNZ and farmers, and volatility in that market seems to lead and/or correlate closely with the Kiwi’s short-term price action.
The Global Dairy Trade Price Index comes out roughly every couple of weeks, so be sure to check with it for short-term cues on the Kiwi!
And before I wrap it up, let’s take one last look at the Kiwi’s performance against the major currencies: