By Roger J Kerr

While the local moneymarkets were pricing in interest rate cuts late last year, changing to pricing in increases a month ago when stronger domestic economic data caused a re-think, the largest determinant of future interest rate direction, the NZ dollar exchange rate, has remained a stable constant through all the flip-flopping around.

The take-out from last week’s RBNZ Monetary Policy Statement was that interest rates are not going anywhere unless the NZD/USD exchange rate returns to the mid to low 0.7000’s.

A currency drop would have significant impact on the current benign inflation pressures and GDP growth would lift again - together, two very good reasons why interest rates would be moving upwards under such a scenario.

Our long-term interest rates are likely to be pulled upwards over coming months with increasing US 10-year Treasury Bond yields as the US economy builds on its current stronger momentum.

It will also be stronger US economic data that strengthens the USD itself in global forex markets and potentially pulls the Kiwi dollar down to the mid 0.7000’s.

So, all roads for our future interest rate direction and the timing of changes lead to monitoring the sustainability of the pick-up we are currently observing in US property, retail and jobs markets.

US household balance sheet values have finally returned to 2007 levels with property and share investment portfolios increasing in value over the last 12 months.

The services sector in the US is 70% of their economy and recent data points to strong gains in services across the economy.

Ben Bernanke’s economic recovery prescription is finally working it appears after a couple of false starts in 2011 and 2012.

It was pleasing to see the RBNZ critically evaluating and analysing their “2012 inflation forecast error” in last week’s MPS statement (Box A. Page 7).

Decomposing and explaining the differences between their inflation forecast made a year ago with actual inflation outcomes provides a good discipline to learn and also to have some accountability for performance. After all, that is what they are paid to do.

Sometimes it does not pay to look back at what you said only a few short months ago; however the largest risk facing the NZ economy today (the drought) was identified by us as a major risk factor in our 3 December 2012 commentary :

One clear risk to the still positive economic outlook is the possibility of a dry summer for our farmers and agriculture production being significantly down on last year. The RBNZ would have to seriously contemplate interest rate cuts if the nightmare scenario of a summer drought and continued high NZD/USD exchange rate above 0.8000 does actually eventuate.

That nightmare scenario has eventuated into reality; however today I don’t think the rampant residential property market allows Governor Wheeler to contemplate cutting interest rates. 

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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