New Zealand dollar bound to be talked down: Currency Outlook and Forecasts

The Reserve Bank of New Zealand did what everyone in the market expected by keeping its OCR base rate at 2.50%. The OCR has now been at that level for 27 months running. By contrast, the RBA has trimmed its base rate from 4.75% to 2.75% over that period.

The result is that in any ranking of G10 currencies by yield, the New Zealand dollar (Currency:NZD) is now 1b, or effectively almost tied for being the high yielder.

Having a high yield tends to attract capital flows to a currency and NZD has had periods when that has seemed to be an issue. However, it is middle of the pack in terms of spot returns amongst G10 currencies over the past year, which suggests that excessive inflows aren’t that big of an issue now.

The shrinking yield differential with AUD is somewhat of an issue on the AUDNZD cross, which is down about 6% Yoyo. That move, along with the move in NZDJPY probably matter a lot more to RBNZ policy makers than rankings against USD and EUR.

With that in mind, it is not surprising that the RBNZ continued its complaint about the strong NZD even though NZD/USD was down 5% between meetings.

Specifically, the RBNZ said in its General Press Release that “Despite having fallen over the past few weeks, the New Zealand dollar remains overvalued and continues to be a headwind…” RBNZ Governor Wheeler was given the opportunity to go a bit further in his press conference and did so, although not with an emphatic tone.

He did say, however, that the RBNZ is “prepared to intervene” and that “if we see an opportunity we will take it.” He later came back and clarified that RBNZ intervention is undertaken to “take tops off” or to address liquidity gaps rather than to offset large capital flows.

He said that the RBNZ would continue to report intervention on a monthly basis but not transaction by transaction.

Wheeler’s remarks initially pushed NZDUSD about 30 pips lower but the pair soon stabilized. Repeating that the RBNZ sees NZD as overvalued should not be seen by the market as a surprise. However, what is interesting is that the RBNZ seems to want the kind of depreciation that AUD has seen over the past six weeks.

I would note that Brazil wanted that kind of depreciation last year but has since seemed to change its mind somewhat. Brazil’s experience is a good reminder that policy makers need to be careful what they wish for when they wish for a weaker currency.

A weakening currency chases away foreign investment and causes inflation that may force the central bank to raise interest rates when the economic situation doesn’t otherwise justify it. I would not be surprised to see the RBNZ in that type of predicament within a couple of years. In the interim, if the RBNZ is asking the market to sell its currency, then by all means…