The Reserve Bank left the official cash rate unchanged at its meeting last week. However, they forecast that future interest rate rises would be much slower with a 0.25% rise over the next year versus a 1.0% rise that it forecast in its December statement. The major reason for the change appears to be the strength of the $NZ which helps to contain inflation through cheaper imports and reduced exports. The RBNZ looked to talk down the value of the $NZ by stating that sustained strength would reduce the need for future increases in the OCR and that the high value of the $NZ is detrimental to the tradable sector, undermines GDP growth and inhibits rebalancing of the New Zealand economy. Whilst the $NZ fell initially following this commentary it soon recovered these loses.
The problem for the RBNZ is that although they would like a lower $NZ they have little control over its level other than through keeping interest rates low and therefore reducing the attractiveness to foreign investors. However, despite historically low NZ interest rates our rates are still much higher than those in most developed economies. In the US official cash rate is close to zero and the US central bank has forecast rates to remain low until 2014. Forecasting the $NZ is very difficult, however, New Zealand’s superior growth prospects, higher interest rates and low level of government debt mean it is likely to remain supported over the medium term. The major negatives for the $NZ are a sharp slowdown in growth in China and potential weakness in the prices of our exports. Given New Zealand’s reliance upon offshore capital the $NZ can fall sharply if offshore investors become less positive on New Zealand’s outlook.