New Zealand’s rate of inflation has just fallen to a 13 year low of 1 per cent.
With the global outlook still deteriorating, another small fall at the Global Dairy Trade auction and the New Zealand dollar heading back to US 80 cents, there are only two chances that monetary policy will be tightened this year. As the Aussies say, they are nil and buckleys.
The Reserve Bank tried raising interest rates in the second half of 2010 but had to reverse them immediately after the February 2011 earthquake. It probably would have cut them soon after that even without the seismic event because of weakness in the economy.
So New Zealand’s cash rate sits at the 2.5 per cent it was taken to in 2009. In the same vein, the Bank of England’s cash rate is still at its record low of 0.5 per cent, the US Fed. Funds rate is scraping the bottom at 0.25 per cent, the Japanese rate is 0.1 per cent, and the European rate which was cut to 1 per cent rose to 1.5 per cent, and now sits at 0.75 per cent.
That last number is quite important to note. The European Central Bank is essentially saying that economic prospects now are even worse than they were in the middle of 2009 when their rate hit 1 per cent.
With interest rates at such low levels, there is very little extra assistance which central banks can deliver in Europe and the United States should the economic outlook deteriorate. Unfortunately, a deterioration is exactly what is underway, with United States retail spending falling for each of the past three months and indicators for Europe getting worse and worse.
In fact, in Europe, the Bank of Spain has just revealed that Spanish banks in May had bad debts of €156 billion. That amount is well above the €100b agreed upon less than four weeks ago as a bailout package for Spanish banks.
Not only that, but having printed hundreds of billions of dollars to try and boost growth and having failed, the Federal Reserve has hinted it may print even more. In other words, doing what hasn’t worked already.
But this has relevance for our farming sector. Extra money printing in the US, if it happens, will tend to depreciate the US dollar and thus the NZD risks consolidating above US 80 cents.
In addition, there is a correlation between where sharemarkets go and where the NZD goes, money printing in the past has boosted US equities and probably would do so again, therefore we would get even more upward pressure on the NZD.
Then there is the developing dynamic of the NZD’s movements as things get worse in Europe. In the past, European wobbles would send currencies like the NZD and Aussie dollar lower. But just recently, investors have been taking funds out of Euros and seeking what they believe are safe havens elsewhere.
For two years now, the Japanese Yen and US dollar have been the main beneficiaries of these safe-haven flows. Now we are seeing the NZD and AUD being placed in the same basket as the Yen and USD.
Given my belief the situation in Europe will worsen and US growth is stalling in some (not all) sectors, the chances are high that—even as we see our export commodity prices fall further—the NZD will remain a strong currency.
And just to spoil your day even further, there is a reasonably strong housing lift underway in Auckland which, while not inflationary, does make it very easy to see why the Reserve Bank is highly, highly unlikely to cut interest rates in the near future.
Our incoming Reserve Bank governor is going to straight away be faced with the same problem which beset his predecessors: how to slow a housing rise without causing the export sector to weaken as the currency rises in response to rising interest rates?
My answer is that the interest rates will, in fact, not go up. That might contain the NZD below US 85 cents, but it means the housing cycle has a long way to go, and an increasing number of investors appear to realise it.