FYI | Dec 08 2006
By Greg Peel
Yesterday the Reserve Bank of New Zealand increased its inflation forecast to 2.7% and warned of upside to this number. It also forecast higher bank bill rates – up to 7.7% early next year – and a higher Kiwi dollar. Then it left the official cash rate on hold at 7.25%.
This left many an economist bemused. Why make such predictions and not act on them? Credit Suisse understands there were RNBZ officials asking the exact same question, but the governor’s decision is final and that was that. Credit Suisse believes the RBNZ could have justifiably raised rates a full 50bps.
Nevertheless, the risk remains on the upside. Whereas the governor previously had considered inflation to be “comfortably in the 1-3% range”, it now considers inflation to be “in the 1-3% range”. A subtle difference, but one that is clearly discomforting.
Credit Suisse is advising investors should not be long NZ equities, and the analysts see upside risk to the Kiwi in the short term. However, CS is short the Kiwi for the longer term.
Macquarie is also setting itself for a fall in the Kiwi later in the year. It notes the currency has strengthened considerably against both the Aussie and the greenback recently, based on better than expected (or not as bad as expected) economic data and as a result of global carry trades.
But the analysts expect the Kiwi to weaken in the second half of 2007 following rate cuts in the third and fourth quarters. They also note late 2007/early 2008 brings a big rash of bond maturities which will put the squeeze on the carry trade.
Macquarie expects the Kiwi to be at US$0.60 and A$0.82 by the end of 2007. In the mean time, the RBNZ will keep a watchful eye on the economic data. Despite the rhetoric, it appears the governor is trying hard not to raise rates, which reinforces general expectations of easing next year.
According to the view of Chris Tennent-Brown, NZ economist at the Commonwealth Bank, however, continued inflationary danger will keep the tightening bias intact for some time across the Tasman Sea. Tennent-Brown believes any possible reduction in NZ interest rates appears to be off the table until at least the second half of 2007.