Roger J Kerr says if the $NZ exchange rate stays at current lower levels inflation may lift a lot quicker than everyone expected

By Roger J Kerr

The rapid sell-off in the New Zealand dollar exchange rate against the US dollar over the last few weeks (when other currencies have generally been stable against the USD) has resulted in sharply lower NZD cross-rates to the AUD, EUR, GBP and JPY.

As a result the overall value of the NZ dollar (the Trade Weighted Index – TWI) has plunged 5% from 80.0 to 76.0 over a very short space of time.

The higher TWI over recent years has been a major contributor to the very low annual inflation rate (along with lower fuel prices) as imported consumer goods have generally moved down in price.

Times are now a’ changing with the TWI plunging to the lower levels within a week compared with what the RBNZ assumed would happen over the next 12 months.

Importer currency hedging means that there is a six to nine month lag in higher consumer prices to the current currency depreciation.

If the TWI stays at these lower levels, the RBNZ and the market may well find the CPI increasing to above 2.00% a lot sooner than everyone expected.

The implications for the OCR and mortgage interest rates is obvious.

Off course the RBNZ have been calling for a lower exchange rate for some time and they are now finally getting some traction as US interest rates increase well ahead in timing of any official NZ interest rate increase.

However, the RBNZ may themselves be a little surprised at the speed of the current exchange rate depreciation, potentially lifting the annual inflation rate a lot earlier than their forecast models suggest.

Long term interest rates will continue to increase over coming months as US bond yields only go one way (higher) due to the Fed lifting short term interest rates, stronger US economic data and therefore higher US inflation.

One of the risks for the US bond and equity markets is that the Trump administration continue to delay with the detail for the infrastructure investment and tax cuts.

Ultimately the financial and investment markets may become frustrated and impatient with the delay causing a correction the other way in both markets.

Roger J Kerr contracts to PwC in the treasury advisory area. 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