The kiwi dollar | image via Karl Baron
We asked columnist Peter Nicholl to discuss the ramifications of the fall in value of our dollar.
The Kiwi dollar has been in the news over the last few days for all the wrong reasons.
It has been falling sharply and this has caused concerns about its impacts on future inflation and therefore on interest rates.
People are right to be concerned. But the first thing to work out is whether the Kiwi dollar has, like all other currencies in the world, been hit by the tidal wave of positive sentiment for the US dollar or whether it is sinking faster than most other currencies.
Against the US dollar it has fallen by about 16 per cent this year. That’s a lot. It has also fallen by about nine per cent against the Australian dollar. It has been falling against the yen too over the last few months.
So, while it is the strength of the US dollar that has caused most of the recent weakening in the Kiwi dollar, we have not been a strong performer against other currencies.
There are two main reasons for the recent rapid increase in the value of the US dollar – the amount of political and economic uncertainty in the world and secondly, the US Federal Reserve has recognised that US has an inflation problem and got serious about doing something about it. Two weeks ago they raised their benchmark interest rate by 0.75%. Market participants and commentators had got into the habit of thinking a move of 0.5 per cent was the maximum a Central Bank would do at a time. So the Fed’s larger increase took most people by surprise and got everybody’s attention.
How should other countries respond to this strong move by the US Fed? The new Conservative government in the UK gave everybody a textbook lesson on how not to respond. With UK inflation already higher than in the US, they announced some of the largest tax cuts in UK history. This really spooked the financial markets. The Bank of England moved quickly to buy a lot of UK government bonds. They had to do so for financial stability reasons, especially in their pension industry. But it has injected a whole lot more liquidity into the UK financial markets which is the last thing they needed at this time. It will add to downward pressure on the pound and upward pressure on inflation. The move should have been accompanied by a sharp upward movement in the Bank of England’s base interest rate. Instead, the Governor of the Bank of England has said that he ‘won’t hesitate to raise interest rates to get inflation back to their 2% target’. But he didn’t raise their interest rate when the Fed raised theirs by 0.75%. He didn’t raise the interest rate when the UK Government announced a huge tax cut. He didn’t raise the interest rate when this move led to market turmoil that forced the Bank of England to intervene in the bond market. So he has already ‘hesitated’ several times.
Which brings me to what the RBNZ should be doing given the recent fall in the value of the Kiwi dollar. They should have already made a further upward move in the OCR. The New Zealand OCR is now below the Fed’s official interest rate. That is a guaranteed way to shift the exchange rate in favour of the US dollar.
The UK Government’s extraordinary ham-handed fiscal moves have increased the attention that global financial markets are going to be paying to country’s fiscal policies in year ahead. Prudence will be rewarded and profligacy penalised in the foreign exchange market. New Zealand’s politicians will need to recognise this and be careful what they promise as the election campaign gets under way.
The dramas in the world’s foreign exchange markets are just beginning.
As the big Central Banks finally get serious about the inflation problem that they themselves had a big role in creating, the process of adjustment will not be smooth. New Zealand policy-makers can’t afford to take risks.
Waipā District seems to be a long way from these global issues but even here they will have an impact. Waipā DC has said that over the next decade their debt levels are forecast to rise steadily as investment in infrastructure and community facilities continues.
Debt is going to become more expensive as interest rates rise and those higher rates are likely to stay around for longer than most people had been expecting until recently.
The word driving policy-makers in this uncertain environment should be caution.
