Roger J Kerr won't be surprised by negative GDP in Q3, nor a December cut by the RBA. If our weather goes dry as well, he also sees a rating cut for NZ. Your view?

 By Roger J Kerr

As the established 0.8100 to 0.8300 trading range for the NZD/USD exchange rate extends its duration for another month, it is becoming increasingly difficult to see what will break the shackles.

It seems that it will require something unexpected by the markets that jolts fresh buying or selling of the NZ dollar.

Over recent weeks, weaker than expected local jobs and retail data has pulled the Kiwi down on a couple of occasions.

However, stronger Chinese economic data (lifting the AUD) and/or “risk-on” investor sentiment caused by progress in European debt discussions or apparent progress in the US fiscal negotiations have combined to always propel the Kiwi dollar back up again.

The local financial markets are coming to the conclusion that a surprise cut in our OCR interest rate by the RBNZ will not be the catalyst that causes the NZ dollar to break to the bottom side below 0.8100.

While some economic data supports an interest rate cut, the reality is that the Christchurch rebuild is causing demand and thus price pressures in the construction sector to keep inflation at the 2% region. Add on a resurging Auckland housing market largely caused by already record low mortgage interest rates and the environment is not one where the new RBNZ Governor is going to allow potential future inflation risks to gain any momentum.

The RBNZ’s quarterly Monetary Policy Statement on 6 December will be closely scrutinised by the markets for any possible deviation from the very orthodox monetary stance Governor Wheeler has taken so far.

There is no question that the NZ economy hit a pothole in the road in the September quarter after strong growth in the first half of the year. However, it does not appear to be a permanent turning point lower in the economy, merely more subdued economic activity levels being likely over the next six months as the high dollar value this year curtails exporter expansion and the super agricultural production gains of last year cannot be repeated.

Herein lays one potential negative for the NZ economy and exchange rate value over coming months. If climatic conditions this summer prove to be the complete opposite of last year and a drought hits agricultural production, economic growth will be significantly weaker than expected.

Lower GDP growth (ex Christchurch) would make New Zealand a less attractive investment destination and reduce capital inflows that have been so dominant in maintain the NZD’s strength this year.

While predicting the weather is fraught with danger, risk managers should have contingency plans for a weaker NZ value if we start experiencing a very dry summer.

Both the weather and the currency value play a major role in the performance of the NZ economy with agriculture still the mainstay industry.

The GDP growth figures for the September quarter to be released on 20 December look set to surprise on the downside with a negative result for the quarter not out of the questions. The foreign exchange markets will sell the NZD lower on such an outcome.

Another potential negative for the NZ dollar over coming months is a sovereign credit rating downgrade for the NZ Government. While the Government’s budget deficit situation is improving (if somewhat delayed), a more severe economic downturn due to dry climatic conditions would cause the rating agencies to mark us down. Our private sector debt levels and Balance of Payments Current Account deficit positions are sustainable whilst we have the confidence of foreign investors are receive their voluntary capital inflows to fund the shortfalls. A loss of that confidence would see our economic metrics deteriorate and the rating agencies respond accordingly.

Outside domestic economic variables, the direction of the Australian dollar will continue to be the prime determinant of NZD direction in the currency markets.

The expected weaker Australian domestic economic data has not yet materialised.

The RBA have stated categorically that they will only cut their official interest rates again if the data is weaker. Anecdotal evidence is that the Australian economy has rapidly become uncompetitive on its internal cost structures following years of mining boom, no economic recession and thus no motivation and complacency to manage their costs.

It could be argued that Australia now requires ever increasing metal and mining commodity prices to cover their increasing cost base. China will buy its base metals from Chile, Africa and Russia if Australia prices itself out of the market. Politics remains the essential driver of consumer and business confidence levels in Australia and all political persuasions currently appear bereft of fresh ideas.

While the Australian economy has future challenges, the FX markets have yet to recognise the negatives and still buy the AUD on its superior economic performance and relatively higher bond interest yields. A stronger USD globally may well coincide with some of these Aussie negative factors in 2013 being realised and cause the AUD/USD exchange rate to trade below $1.0000 rather than above it.

In the short term, another RBA interest rate cut sometime in December appears likely and may be enough to pull the AUD below key support lines above $1.0200.

A more conclusive break below 0.8100 in the NZD/USD should see rates with a seven in front of it through the Christmas and New Year Period.

Traditionally, the NZD has increased in early January; this year could be different with extreme global financial/investment market volatility likely in the pre and post 1 January deadline date for the US fiscal cliff resolution or non-resolution.

Market volatility is currently very low, a sharp jolt upwards in volatility measures form here would certainly be negative for the Kiwi dollar.

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 Roger J Kerr is a partner at PwC. He specialises in fixed interest securities and is a commentator on economics and markets. More commentary and useful information on fixed interest investing can be found at rogeradvice.com