25 February 2015 / ContactUs@harbourasset.co.nz / +64 4 460 8300
Australian travellers buying the kiwi dollar at foreign exchange conversion counters in airports are experiencing NZD/AUD parity. In wholesale markets, NZD/AUD could reach parity in the short term, but we expect to see sub 0.90 over the medium term.
Relative central bank policy is a primary driver of exchange rates. There is a strong correlation between expected relative monetary policy stances (illustrated by the 2 year swap rate differential) and the NZD/AUD. The limitation of market indicators, is that they are based on market expectations, which may not be delivered. Last month, the RBA reduced interest rates. With another cut on the horizon, the market could extrapolate these trends putting upward pressure on the NZD/AUD. With the market tendency to jump ahead, we could briefly see the NZD/AUD hitting parity then reverting towards fundamentals in the medium term.
In the long run, the NZD/AUD will tend to be driven by differences between New Zealand and Australian GDP, interest rates, current accounts, inflation and money supply. Currently the market is focused on deteriorating Australian fundamentals with another RBA cut in the pipeline and weaker resources forecasts as Iron Ore and Oil prices fell over 50% in the last year. However, New Zealand fundamentals also point to a weaker currency - moderating GDP growth, the RBNZ announcement in January that the OCR will be on hold for longer, inflation at 1% at the lower end of the target band, and a persistent current account deficit. In New Zealand there is also a weaker commodity story, with whole milk prices falling over 50% in the past year, although there was a small recovery on low volumes in February. Balancing the New Zealand and Australian fundamentals, our model suggests fair value is under 0.90, which is higher than the long run average reflecting New Zealand’s economic strength relative to Australia, but well under the current level of the NZD/AUD cross rate.
Harbour’s research is available on their website, see: www.harbourasset.co.nz
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