The New Zealand bond market should survive the latest drop in the New Zealand dollar, according to Westpac’s acting chief economist, Michael Gordon.
Thursday, September 15, 2022, 8:40 a.m.
by Eric Frykberg
But it will not be without risk if the fall materializes in a sustained decline in the value of the Kiwi.
The problem is the New Zealand dollar’s plunge below 60 cents US for much of Wednesday.
This came after US inflation turned out worse than expected: 8.3% in the 12 months to August.
This led investors to turn to the US dollar in anticipation of higher interest rates imposed by an inflation-averse Federal Reserve. This demand pushed the US dollar higher and dragged down other currencies when measured against it.
By forcing the New Zealand dollar down to a level not seen two years ago and well below the average of the past ten years, this trend seemed to raise the possibility that imported goods paid for in US dollars would cost more New Zealand public.
That in turn would drive up inflation here overall, make the Reserve Bank very jittery, and possibly cause the banks to force everyone to pay more on their mortgages.
But Gordon is cautious, saying it’s too early to draw a conclusion. He says this is because a small drop in the exchange rate has a limited impact on inflation per se.
“There is a relationship of about ten to one between the exchange rate and inflation. Thus, a sustained 10% fall in the exchange rate would add about 1% to the inflation rate for one year.
Clearly, the latest dip below $0.60 is nowhere near that threshold. But he points out that over time there has been a significant decline in the Kiwi, which was over $0.70 less than a year ago.
So what impact would this have on interest rates?
“Whether that moves the Reserve Bank into increasing the official exchange rate even more, well, that makes it harder for them, but they don’t have a mechanical answer to that.
“That may have some influence, but it’s not the main source of inflation they’re worried about.”
BNZ economist Craig Ebert agrees that in itself the latest dollar drop is quite marginal.
“But overall it doesn’t help and it reinforces an inflationary image, because a lot of it comes from abroad. About half of the CPI is exposed to global inflationary forces, so it contributes to the possibility that inflation will persist at a high level.
But Ebert points out that his team has been predicting a dollar at this level for some time, so they are not adjusting their forecasts based on this development.
He adds that the impact of exchange rates on inflation should be assessed against the trade-weighted index of the currencies of the countries with which New Zealand trades, not just against the US dollar, which he says is gaining against many other currencies, not just New Zealand. Zealand dollar.
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