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Roger J Kerr says because of hedging, the NZD can depreciate significantly over the next 6-12 months and the impact on inflation will be muted

Currencies
Roger J Kerr says because of hedging, the NZD can depreciate significantly over the next 6-12 months and the impact on inflation will be muted

 By Roger J Kerr

Has the RBNZ delivered the final body blow to the Kiwi dollar’s relentless appreciation over recent years?

Tumbling dairy commodity prices and a stronger US dollar have been suggesting a weaker NZD, however to date increasing interest rates in New Zealand were still pushing the currency up.

The official pause in further interest rate increases has created an opportunity for a sea change in the New Zealand dollar’s direction.  

Initial foreign exchange market price action since the RBNZ’s OCR review last Thursday suggests the scales have finally been tipped in favour of a weakening trend from here for the NZ dollar.

The NZD/USD dropped one cent from 0.8700 to 0.8600 immediately following the clear-cut messages from Governor Graeme Wheeler on Thursday 24 July.

Offshore markets continued the Kiwi selling through Thursday and Friday, the rate falling away to lows of 0.8540.

The sharp 2 ½ cent pull-back in the exchange rate from the 0.8800 highs has broken key chart points resulting in the Kiwi now being within striking distance of the 200-day moving average support line at 0.8450.

As expected, the RBNZ took the opportunity of the fourth 0.25% OCR increase this year to deliver an accompanying message that was much more effective in jawboning the NZ dollar lower than previous attempts.

A crafty and careful choice of words from RBNZ Governor Wheeler caused the desired response form the FX markets.

The “unjustified” and “unsustainable” descriptions for the currency value were designed to convey the message that the RBNZ believed the necessary four prerequisites were fulfilled to intervene in the foreign exchange markets selling the NZ dollar.

The markets quickly got the message that they were on notice that central bank intervention was imminent.

The sharp change in tone and intent in this statement from the RBNZ compared to the 12 June MPS messaging (which drove the NZD/USD rate up four cents from 0.8400 top 0.8800) suggested that the RBNZ had belatedly realised their overly-hawkish signal in June was potentially damaging to the economy.

To be fair, the continuing reductions in dairy prices and a stronger US dollar on global FX markets over recent weeks created a more conducive environment for the RBNZ to be more effective with the currency jawboning.

My further reading of the RBNZ’s changed approach is that they have also recognised that the NZ dollar can depreciate reasonably significantly over the next 6-12 months and the impact on the inflation rate will be muted and delayed.

Importers have much higher levels of currency hedging in place than normal and the RBNZ are recognising this.

The technical support area at 0.8450 could well be tested to the downside this week from two sources:

- Fonterra are expected t0 announce an update to their 2014/2015 milksolids/kg payout forecast to dairy farmers this week. The headlines on the newswires from New Zealand’s largest industry will not be that positive with the reduction in the payout to somewhere near $6.00/kg this next season from $8.40/kg last season wiping more than 1.0% off our GDP growth.

- Continuation of the renewed US dollar strength coming from US GDP growth figures, the Federal Reserve meeting and US monthly employment numbers on Friday.

The Euro has dropped below its long-term support line against the USD and looks set to weaken further to $1.3000. At 0.8550 the NZD/USD exchange rate is challenging its 12-month uptrend line.

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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

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