The probability of a sharp fall in the New Zealand dollar appears to have increased, with this likely to occur if global economic conditions continue to deteriorate, the Reserve Bank of New Zealand says.
The RBNZ made the comment in its November Financial Stability Report, in which it said risks to New Zealand’s economy and financial system had increased since May, due to turbulence and uncertainty in global markets.
“As global risk appetite has shifted towards safe havens more recently, the NZD has depreciated against the US dollar,” the Reserve Bank said.
“Carry trades have become less attractive, particularly as exchange rate volatility has increased. The cost of insuring against NZD depreciation implied by option prices has also increased, suggesting that the perceived probability of a sharp depreciation in the dollar has increased,” the RBNZ said.
Sharp depreciation would likely occur if global conditions deteriorate and investors sought to reduce exposure to risky positions such as carry trades on the New Zealand dollar.
“With most of New Zealand’s debt effectively denominated in domestic currency, a depreciation of the NZD would help to insulate the New Zealand economy in a global downturn scenario, and would not be expected, by itself, to create significant financial stability risks,” the Reserve Bank said.
The New Zealand dollar had risen to a post float high of 88.4 US cents in early August, on the back of robust emerging market growth and strong and strong gains in commodity prices, the RBNZ said.
“‘Carry’ trade inflows also supported the NZD and the Australian dollar, with low US interest rates and strong risk appetite encouraging investors to borrow in US dollars and to invest in higher interest rate environments,” it said.
“Some emerging economies with relatively high interest rates also experienced significant carry flows.”
(Updates with video)