New Zealand exporters and business now face the prospect of a high currency holding back the tentative recovery for them.
As well, recovery for the wider economy will be a slow, at time tortuous affair.
With yesterday’s decision to lift its key interest rate 0.25%, the first increase three years, to 2.75%, the bank signalled that it has come down on the side of restraining inflation rather than trying to weaken the value of the dollar, even though Bank Governor, Alan Bollard, says that a lower value for the currency would be desirable.
The Kiwi dollar is the second best performed currency so far this year (after the yen): it jumped sharply yesterday immediately after the rate rise increase was announced, from 66.70 USc to around 67.05 USc.
A London economist quoted on Bloomberg summed up the outlook for NZ:
“The kiwi dollar will probably stay too strong,” Kevin Grice, a senior economist at Capital Economics Ltd. in London, said before the report. “The recovery will end up being a long, hard slog.”
Governor Bollard said in his post meeting statement that the country’s economy "has entered its second year of recovery with growth becoming more broad-based.
“The recovery in trading partner activity is continuing, with growth in Asia particularly strong.
"Along with ongoing growth in Australia and recovery in the United States, this has so far offset weak growth in some other export markets.
"Against this backdrop, New Zealand’s export commodity prices have increased sharply over the past few months, boosting export incomes.
“In contrast to signs of global economic recovery there has been renewed turmoil in financial markets.
"Currently, we expect the main impact on New Zealand to come through continuing upward pressure on the cost of funds to the banking system.
“In New Zealand, growth of around 3½ percent is expected this year and next.
"The main drivers of this outlook are higher export prices and volume growth, an improving labour market and a pick-up in residential and business investment.
"However, we expect households to remain relatively cautious, with the housing market and credit growth staying subdued.
"This moderate household spending contributes to some rebalancing in the economy.
“Underlying CPI inflation is expected to track within the target range even as the economy expands further.
"That said headline CPI inflation will be boosted temporarily by the announced increase in GST and other government-related price changes.
"Provided households and firms do not reflect this price spike in their wage and price-setting behaviours we do not expect a lasting impact on inflation.
“Given this outlook and as previously signalled, we have decided to begin removing some of the monetary policy stimulus that is currently in place.
"The further removal of stimulus will be reviewed in light of economic and financial market developments.
“The fact that bank funding costs are higher, long-term interest rates are higher than short-term interest rates, and a greater proportion of borrowers use floating rate mortgages should all reduce the extent to which the OCR will need to be increased relative to previous cycles,” Mr Bollard concluded.
In fact the boost to the cash rate was probably forced on the central bank by the recent budget and its "temporary" boost to inflation.
That is expected to peak at around 5.3% next year after the rise in the GST to 15% from 12.5% happens, along with several other changes (higher tobacco tax).
That is expected to boost prices by around 2% in the next year. It should be easing towards the end of 2011.
Inflation is expected to peak at 5.3% in the year ending June 2011, and then ease, according to the RBNZ forecast yesterday.
Prices were up 2% in the March year, and are expected to be back to around 2.8% by the end of March 2012.
Excluding the boost from the budget tax changes, the RBNZ said inflation will peak around 2.6% in the next year, just under the target range of 1% to 3%.
The higher rate and expectations of at least one more rise (to make sure that inflation doesn’t stay out of line) will boost the value of the NZ dollar in coming months, crimping export returns.
The Governor and the bank know that will be the outcome of the rate increase, even though Mr Bollard said last month that a gradual depreciation of the kiwi “remains desirable”.
That’s not going to happen, although the currency will be buffeted (like the Aussie) by the continuing volatility emanating from Europe and those still strong fears about risk.
The NZ and Aussie dollars are both regarded as commodity currencies, good for trading in via the euro/US carry trade and easy to quit if there’s a rise in risk aversion.
But the NZ Reserve Bank has now started along the same track as the RBA did in October 2009 of ‘normalising’ rates and monetary policy.
The outcome will be similar: a gradual easing in consumption and in sectors such as retailing, as we have seen in Australia.
The NZ dollar has risen more than 6% against the greenback in the past year, and that strength will continue (subject to the odd scare), making life a little bit tougher for exporters, retailers, banks and home buyers.
