The New Zealand dollar has risen strongly this year, up over 5.0% versus the United States dollar. This has been driven by a number of factors including the different interest rate policy of the NZ and US central banks. Both central banks announced policy on Thursday morning our time with the US Federal Reserve indicating that it expects to leave its cash rate unchanged at close zero until 2014. The Reserve Bank of NZ left our cash rate unchanged at 2.5% reflecting the uncertain global environment and a modest pace of domestic demand.
The interest rate differential and the confidence that it will remain provides support for the $NZ as investors can, through the foreign exchange forward market, borrow $US and invest in $NZ and receive a return premium of around 2.5% p.a. The $NZ is currently also being supported by improved sentiment in financial markets which has encouraged investors to increase risk.
The fact that interest rates are forecast to remain low for a long-time reflects the low world growth and inflation environment as over indebted consumers and governments look to repay debt. The risk for the $NZ is that this rebalancing leads to a sharp slowdown in global growth and lower demand and prices for our commodities. A deteriorating outlook will also increase the premium required for investors to take the risk of funding NZ’s deficits.
Forecasting currency in the short-term remains difficult as whilst risk on sentiment is currently prevailing and supporting the $NZ, markets remain fickle and a change in sentiment could easily see those investors who have bought the $NZ look to sell the currency and take profits sending it lower. However, on a medium-term basis we believe that the $NZ is likely to remain relatively strong against the $US supported by our higher interest rates and better growth outlook.