Kiwi tipped to stay high until interest rates fall

The New Zealand dollar is likely to remain strong until New Zealand's interest rates are no longer seen as advantageous to overseas investors, ASB chief economist Nick Tuffley says.

The dollar fell significantly after Fonterra released a sharply revised milk payout.

However, if the Reserve Bank continues with interest rate hikes, the dollar is expected to recover.

For the dollar to substantially soften this year, a marked change in the global risk environment or a lurch downward in China's economy was required.

An added challenge for the New Zealand Reserve Bank was the process of ''normalising'' interest rates was happening largely in isolation within the developed world, he said.

That meant New Zealand was attracting interest from global investors seeking yield, Mr Tuffley said.

The dollar fell from recent highs after the Reserve Bank hinted it might intervene in the currency market.

Finance Minister Bill English has also indicated he believes the currency was too high.

The global backdrop was one of extremely loose monetary policy in the major developed economies, meaning the United States dollar, pound sterling, the euro and yen had been weak.

Mr Tuffley said in order to access the higher returns available in New Zealand financial markets, global investors must sell their local currencies and buy New Zealand dollars.

The lift in demand made the dollar stronger relative to other currencies.

On one hand, a stronger dollar helped the Reserve Bank with its goal of maintaining price stability.

But the bank also needed to avoid unnecessary instability in terms of output, interest rates and the exchange rate.

''And it's here where the Reserve Bank has a problem with the exchange rate.

"When the dollar is too high, it can make some of New Zealand's exporters and manufacturers uncompetitive and, in turn, is a threat to economic growth.''

New Zealand's growth had been healthy and the country's risk profile was low.

Until recently, key export prices had been high, reflected in the 40-year high in the terms of trade.

In that sense, the high dollar was justified, he said.

Record export receipts over the past year showed the export sector was coping well with the high dollar, even though it was tough on some.

However, despite the recent fall in export prices, the dollar had remained stubbornly high, even appreciating further while dairy and forestry prices had fallen.

''The pull of interest rates is dominating the moderation of export commodity prices.

"We expect New Zealand's relative interest rate advantage over the rest of the world will continue to hold the dollar up into early 2015.''

The Reserve Bank would prefer higher interest rates to contain domestically generated inflation pressures, but a lower dollar to aid a better balance of economic growth, Mr Tuffley said.

Continued strength in the dollar would leave the central bank having to moderate interest rate rises more than it might otherwise wish to, he said.

The dollar had shown in the past it could deviate from commodity price movements.

In 2012, the dollar was strong despite commodity prices falling, and in 2000 commodity prices rose while the dollar eased, he said.

''We do expect the dollar will start to soften on a sustained basis next year.

"The Reserve Bank is presently about halfway through its tightening cycle and we expect it will finish in the second half of next year.

"By that point, the central banks of other countries will be either lifting interest rates themselves or be very close to it and New Zealand will no longer look special.''



Dollar forecasts


2014: September US86c; December US87c.

2015: March US88c; June US85c; September US82c; December US80c.

2016: March US77c.


At a glance

• New Zealand dollar unlikely to soften until next year.

• Yield likely to underpin demand for the kiwi.

• The euro pushed higher against the US dollar after last week's losses in a quiet forex market.

• The Australian dollar moved back above US94c, getting a boost from improved Chinese industrial profits.


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