Kiwi dollar strong because so is NZ, says Harbour Asset

Friday 4th May 2012

New Zealand's dollar remains stronger than exporters see as comfortable because the local economy is performing relatively strongly, compared to many trading partners, says Harbour Asset Management in its latest fixed interest commentary.

"If the foreign exchange market is a beauty contest between economies, New Zealand has been the best of a reasonably ugly bunch over 2011 and 2012," writes head of fixed income Christian Hawkesby.

The Green and Labour parties have been calling on the government to introduce new measures to allow the Reserve Bank to manage the exchange rate and the central bank is threatening to cut the official cash rate below its current historic level of 2.5 percent.

However, Harbour Asset Management says financial markets are over-estimating the likelihood of that outcome, given evidence the Christchurch rebuild is now starting to have an impact on domestic economic activity and a recovery in the Auckland housing market.

"If the New Zealand economic recovery falters from a fall in commodity prices and stubbornly high exchange rate, then the RBNZ would be more than justified in cutting the OCR," said Hawkesby. "But that is not the RBNZ's central view of the economy, and it not our view either."

Harbour Asset is advising clients to hold short-duration fixed-interest positions "on the view that the market is putting too much probability on the RBNZ cutting interest rates."

The bank's governor, Alan Bollard, warned earlier this month that a rate cut was possible and indicated it would be longer than previously expected before the OCR was increased.

Hawkesby points to correlations between recent sustained periods of kiwi dollar strength and times when New Zealand economic data has "surprised on the upside" in comparison with other countries' performance. That includes Australia, where the central bank this week surprised markets with a larger-than-expected 50 basis point cut to 3.75 percent, reflecting domestic economic weakness and fears of a "hard landing" for the Chinese economy.

However, Harbour Asset doubts the RBA will deliver on further rate cuts, which could take the Australian benchmark interest rate to levels lower than at the height of the global financial crisis in 2008.

"While we think the RBA may take further steps to ease policy, our view is that the magnitude of cuts priced-in by the market is not likely or warranted. We expect long-term interest rates in Australia to rise over a medium-term horizon."

Recent movements in Australian and New Zealand government bond rates had also opened up opportunities for investors seeking value in New Zealand paper, reflected in the heavily over-subscribed $900 million bond tender conducted by the Debt Management Office last week, Hawkesby said.

BusinessDesk.co.nz

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