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Apparently, any speculation that the pace of recession was easing was not enough. My buddy, Reserve Bank of New Zealand Governor Alan Bollard, and his crew decided not to raise the bank’s benchmark interest rates, leaving it at 2.5%. Bollard said that the RBNZ would probably keep the rate at low levels for the time being as he expects inflation to keep in line with the RBNZ’s target between 1% and 3%. Bollard even went as far to say that the bank might slash rates further in the near future if economic conditions do not continue to ease.

Well, there’s no denying that the possibility of another rate cut would set off warning bells for traders. They set the “Kiwi” loose right after the announcement was made, causing it to plummet by more than 90 pips in a heartbeat! Of course the recent comeback of risk aversion, which was triggered by a 2.5% drop in US durable goods orders, also weighed the “Kiwi” down. Long positions were opened up in anticipation of an upbeat RBNZ statement – possibly caused by recent positive statements coming out from their mates in Australia. But even as the “Kiwi” climbed to 0.6582 prior the report, downbeat comments from Bollard pushed price down to a low of 0.6478.

Despite the recent jump in NBNZ Business Confidence Index in July from 5.5 to 18.7 and the surprise upside in May retails sales, New Zealand’s economy is not as rosy as it seems. Building consents, which is used as an indicator of future consumer demand, also made a nose dive by falling 9.5%. The sudden slide indicates that the housing industry is still relatively unstable. Meanwhile, the country’s annualized trade deficit in June has expanded to NZ$3.18 billion from NZ$2.97 billion in May. The primary culprit for the export sector’s downturn? Weaker commodity prices and the whopping 25% appreciation in the domestic currency’s value.

One of the main worries of the RBNZ now is the NZD’s surging value. The recent strength of the NZD versus the USD and the JPY is causing some concerns amongst bank officials about the prospect of SUSTAINABLE economic recovery, especially since New Zealand’s export sector composes a large chunk of its economic activity. Basically, if the “Kiwi” appreciates too much, it causes the relative price of New Zealand’s exports to rise as well which of course dampens overall demand.

Take note that the main reason why the NZD has done well the past couple of months is because of the run of risk appetite in the global capital markets. Investors are looking for higher yielding assets and with New Zealand providing one of the higher interest rates amongst majors (2.5% vs. the 0.1% of JPY and 0.25% of USD), investors’ funds and money naturally gravitate towards it. Cutting interest rates would make the NZD relatively less attractive and would effectively weaken the investors’ demand for it. Conversely, a depreciated NZD would stimulate the demand for New Zealand’s exports and this would reflect positively on the currency on the longer term.

It seems that traders have way overshot the NZD’s value. New Zealand’s underlying fundamental health still remains shaky and it just makes me wonder how long the NZD can keep trading in its current levels. With the combination of verbal intervention and the hints of further rate cuts weighing down heavily on the “Kiwi,” the possibility of the currency losing ground against the USD and the JPY, at least in the medium term, is certainly something to watch out for.

Thanks for checking out my blog and have a great weekend!