By Gareth Vaughan
New Zealand and Australia are playing catch up with the rest of the world with interest rates heading south, meaning the NZ dollar's likely to weaken over the next six to 12 months says Dan Bell, director of sales at HiFX.
"Our cash rate is at 2.75% at the moment and the market is expecting that to be cut to at least 2.5% over the next three to six months," says Bell.
"The timing of that, as the Governor said this morning, will depend on how the housing market plays out and that's going to be an ongoing concern for the Reserve Bank as house prices in Auckland and across the country seem to continue to go higher."
"So balancing weaker global commodity prices and what appears to be a bit of slower global growth at the moment, I think the Governor also wants to leave some firepower in monetary policy because if we were to cut rates too far then the effectiveness of monetary policy going forward, if we were to enter into a recession, would be a little bit muted," Bell says.
The next OCR review is due on October 29. Bell expects no change, but acknowledges about a 30% chance of a cut meaning an easing bias remains in place.
Will they or won't they?
Internationally the spotlight remains on the US Federal Reserve, which has been expected to increase the Fed Funds Rate for the first time in nine years this year but hasn't, and now has just two Federal Open Market Committee meetings left in 2015. The first wraps up on October 28, and the second on December 16.
"The October meeting is no, they're not going to raise interest rates in October, the market is pretty much certain of that. December though is still on," says Bell.
Last October the Fed brought the curtain down on its Quantitative Easing, bond buying, or money printing programme that was put in place at the height of the Global Financial Crisis in 2008. All up, this saw the Fed add US$3.7 trillion worth of assets to its balance sheet, which was about an eight-fold increase. However, the Federal Funds Rate, the US equivalent of New Zealand's OCR, remains at 0 to 0.25%, where it has been since December 2008.
"At the last Fed meeting they referenced some of the global uncertainty, particularly what's happening in China, as impacting their decision. Obviously the US economy has been performing better over the last couple of years and continues to show signs of improvement. But then you get a little bit of patchy data like we had last month, with the US employment numbers coming in a little bit weaker than expected, and suddenly everyone's questioning whether or not the Fed will indeed start raising interest rates," says Bell.
"Now if you actually go back to earlier in the year Fed policy makers were pretty certain that they would start raising interest rates this year and so there is a little bit of credibility on the line with the messaging and communication that's coming out from the Fed. They pretty much said that rates would go higher this year and suddenly we're getting some of the Fed policymakers contradicting each other."
"There's various voting members on the committee and from time to time you get speeches...completely at odds with each other. One saying that we probably won't see rate hikes until March 2016, and another one saying they should have raised rates already," Bell says.
The market "starting to push out the potential for the Fed to start raising interest rates" is a key factor behind the NZ dollar's recent rally to as high as US67.40 cents from around US62c. Bell puts the odds on a December Fed rate hike at about 50/50.
Asked where he sees the NZ moving through the balance of 2015, Bell suggests most of the damage has probably already been done.
"Overall we continue to see the NZ dollar weakening over the next six to 12 months as this commodities cycle continues to unwind and monetary policy continues to come in to support that, which means lower interest rates in New Zealand and probably lower interest rates in Australia next year."
"Some analysts in Australia are calling the Cash Rate down to 1.5%. I think if we see that the Reserve Bank (of NZ) will be under pressure to see our (Official) Cash Rate down as low as 2%, which would be the lowest that we've ever been. So I think low rates are here to stay," Bell says.
"Even if the Fed do raise interest rates by 25 basis points the Fed Funds Rate is still under 1%. In the UK inflation is pretty much non-existent and their inflation this week came in negative, so interest rates in the UK don't look like they're moving. Japan is still printing money, Europe is still printing money. So in this context the new normal is lower rates for longer and I think New Zealand and Australia are playing a bit of catch up with the rest of the world in terms of where our cash rate and our interest rates need to be over the next six to 12 months," adds Bell.
Dan Bell is director of sales at HiFX, a UK-headquartered foreign exchange dealer with significant operations in Australia and New Zealand. It has a dealing room in Auckland. See more detail here.