Business editor Dene Mackenzie reports that more currency volatility can be expected this year as the economy continues its recovery.
The New Zealand dollar will continue to benefit from the brighter global outlook and the fact that the New Zealand economy emerged from the recession in decent shape, economists say.
Commodity prices resumed their upward trend late last year and reflecting those developments, New Zealand-United States interest rate spreads soared as markets anticipated a return to Reserve Bank monetary tightening in the first part of the year.
BNZ Capital currency strategist Mike Jones said his view of the dollar remained essentially unchanged from the one he had held for most of last year - the dollar was expected to continue on its rocky road higher until around mid-2010.
As a growth sensitive currency, the dollar would continue to be buffeted by global risk appetite and changes in perceptions of future global growth.
"Indeed, nervousness about the global picture has been a key factor behind the recent case of NZ dollar wobbles.
However, the bigger picture is one of a strong recovery in global economic growth."
Policy makers around the globe have stressed they are in no hurry to remove policy stimulus.
According to the most recent set of consensus forecasts, global growth of 2.8% was expected in 2010 - very much a "V-shaped" recovery, he said.
"We think there are some risks to this view, in particular the fact that global growth may be constrained in future by a reduction in leverage and a sizeable debt overhang."
Recent data, while patchy, had broadly confirmed the global recovery was on track, Mr Jones said.
Importantly for New Zealand, the recovery looked to be the strongest in Australia, China and other parts of Asia - all key trading partners.
Should that continue, global appetite for risk was likely to head higher, paving the way for further gains in the dollar.
The improving global backdrop should also support further gains in commodity prices.
The global price of New Zealand's export "bundle" had risen nearly 40% from last February's lows, he said.
While the gains had been led by a "whopping" 75% in dairy prices, the strength was becoming more broad-based.
Gains in New Zealand interest rates were one of the key supports for the dollar during the second half of last year as speculation grew about when the Reserve Bank might eventually increase the official cash rate.
Current pricing implied the first 0.25% hike would come in March with a total of 2.25% of tightening by the end of 2010.
"Timing semantics aside, a ramping up in the Reserve Bank's policy rate will certainly add to the allure of the dollar over the next 12 months.
"To us though, the pace of expected tightening looks a little rapid given the still fragile state of the New Zealand economic recovery.
As such, we'd argue the risks are now tilted towards a mild rally, which would act to slow future appreciation in the dollar."
Mr Jones said a lot had been written already on the outlook for the US dollar during the next 12 months.
Unlike many, he did not expect a US dollar capitulation any time soon.
The US dollar was expected to remain the world's reserve currency for the foreseeable future and, in time, should strengthen as the US economy recovered.
The BNZ view was that the US dollar would probably continue to gradually drift lower through most of this year.
Not only did the US have to deal with the well publicised "twin deficits" but recent rhetoric from the Federal Reserve was indicative of US interest rates remaining at low levels for a while yet, he said.
While Mr Jones expected the New Zealand dollar to move higher against the US currency during the first part of the year, he thought the rising currency would eventually become too much for the economy to bear.
By mid-year, the braking effect the strong currency and rising interest rates were having on the New Zealand economic growth would become apparent.
By then, the dollar would be overvalued by about 30% against the US currency.
"As investors are forced to reassess the outlook for New Zealand growth, we'd expect the currency to lose some friends. The more sharply the dollar rises before then, the greater the risk of a material crunch later on."
Mr Jones' forecasts had the New Zealand dollar peaking around US78c by June.
