New Zealand Dollar Could Be 'On Borrowed Time' say ANZ

Despite a relatively buoyant economy the impact of global deflationary forces will force the Reserve Bank of New Zealand to cut interest rates once more argue ANZ Research.

The New Zealand Dollar (NZD) could be about to weaken as a rising number of bank analysts begin to adopt increasingly firm expectations that the Reserve Bank of New Zealand (RBNZ) will cut its base lending rate (OCR).

The latest institution to argue strongly in favour of fresh interest rate cuts are ANZ Research.

According to an in-depth analysis by ANZ Bank, the economic and monetary situation in New Zealand now provides sufficient cause to expect the RBNZ to cut its OCR by at least 50 basis points in 2016, bringing it from a G10 high of 2.5% down to only 2.0%. Lower interest rates weaken a nation’s currency as they attract less international capital.

Falling interest rates will ensure that the yield advantage enjoyed by New Zealand asssets will fall further. International demand for these assets will likely fall as a result ensuring less demand for the NZD.

ANZ’s economic team cite three fundamental pillars supporting their increasingly dovish outlook;

The first is that, “a moderation in economic momentum, now appears to be around the corner at a time when inflation is weak,”

The second is, “global unease,” due to China’s problems – “and they (China) will export them.”

The third and final reason Is rising “funding costs” which if not “compensated for by monetary policy, will accentuate decelerating economic momentum.”

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In terms of the outlook for the NZD currency, the note says:

“We are turning more outright negative on the NZD. In short, its resilience in the face of growing global risks is on borrowed time now the OCR is likely headed lower.

"Weakening export prices and an expected rolling in the economic good-news story are also strong sell signals, particularly when viewed in combination with the current NZD level. Moreover, Fed rate hikes expectations are low. Amidst still-solid jobs and inflation data, USD rebound risks are on the table."

The Bank expects the RBNZ to cut rates by 50 basis points in two 25bps tranches in June and September.

A fall in the RBNZ’s core inflation measure, however, might encourage a move in April, “as there will be no point in waiting till June.”

“Technically we place an equal probability on either an April or June cut at present. Our Monthly Inflation Gauge will help shape our view on the risk profile surrounding the Q1 CPI.”

The view echoed J P Morgan's Laura Fitzsimmons, who said in an interview with Bloomberg, early on Monday February 29, that she expected the RBNZ - not the RBA, to be the most likely candidate for another rate cut.

She was discussing whether emerging market assets had reached fair value for investors, but said that the NZD and Aussie were more likely to garner support instead, because of their relative safety and higher yield. 

Rising Interest Rates

Nevertheless, the ANZ report confirms that the single biggest factor which, “pushed them over the edge,” was the rise in the cost of funding in New Zealand.

“Financial conditions have tightened a lot, and rapidly. House prices, credit spreads and the NZD are all contributing. It is now looking like 2% GDP growth (i.e. below trend) could again be on offer (and that’s assuming no further tightening)."

The speed of the tightening has been particularly notable as the last time we saw a tightening this rapid over six months, the Asian crisis was unfolding.

The GFC tightening was more aggressive overall, but not as rapid in the first instance.

One of the reason for the rising cost of credit is:

“One factor influencing spreads is diminished liquidity courtesy of increasing regulation. Borrowers must eventually pay the cost.”

ANZ said there are “tell-tale signs,” credit costs are likely to rise yet further:

“The recent scaling down of cash-back offers, gifts and fee waivers for mortgage lending is a sign something is up. We are keeping close tabs on retail deposit rates for signs of movement. When these move up independent of moves (rises) in wholesale interest rates, it signifies greater competition for funding from this source. Eventually carded mortgage interest rates will follow.”

The increased cost of funding is major factor in expecting RBNZ to cut rates, as otherwise what momentum the economy has is at risk of stalling even more:

“Higher funding cost pressures are a strong argument for the RBNZ needing to cut the OCR as an offset. However, monetary policy has a number of balls the air, such as inflation, financial stability risks, the NZD, and re-leveraging style behaviour. So by itself, higher funding costs are only a partial argument for a monetary policy response.”

ANZ remain overall quite optimistic about the economic conditions, providing suitable monetary conditions are implemented:

“We are still constructive on the outlook for the New Zealand economy, but part of this is contingent on an appropriate relaxation in financial conditions via both the NZD and OCR settings over 2016.”

Dairy Prices to Reach a Bottom

As far as the outlook goes, the ANZ economic team also argue that they see a “bottom” in dairy prices (which are scheduled to have their next auction tomorrow, on Tuesday 1st):

“Dairy prices appear to have established a bottom and we expect some improvement at this week’s GDT auction, driven by a seasonal fall in auction volumes and bargain hunting. Price direction is likely to be mixed for the different products, however. NZX futures are pointing to an approximate 10% lift for WMP, but a small fall (1-2%) for SMP, for example.”

Economy is 'Ok'

ANZ are overall positive about the New Zealand economy, which they say has many positive aspects (not forgetting its acclaimed film industry...) which have so far helped offset the drag on inflation caued by falling commodity prices and lower dairy payouts, however, these are now increasingly proving unable to contain mounting disinflationary forces:

“Up until now, there have been material offsets to the above drags on inflation and activity, which were enough to keep us in the no-change camp. The economy has been performing well, as has the labour market.

“Capacity constraints are apparent in some sectors; capacity utilisation is high. Core inflation – according to the RBNZ’s preferred measure – has been rising.

“Outside of dairying, exporters are faring okay. Tourism is booming. The tone of the (lagging) domestic data, as well as anecdotes on the ground, remains consistent with a domestic economy that has reasonable momentum right here and now.

“Households are showing re-leveraging behaviour off an already leveraged balance sheet. Regional house prices are rising strongly. Such forces are strong considerations still.”