Since Thursday’s Reserve Bank announcement on interest rates, the New Zealand dollar – often simply referred to as “the kiwi” – has dropped sharply.
Before Adrian Orr released his decision on what to do with official cash rate (OCR) at 9am on Thursday, a New Zealand dollar was buying US67.5 cents, but by 1pm on Friday, it had fallen to about US66c.
That may sound like a small move but over such a short period of time it constitutes a sharp fall.
Even before the drop, Orr, New Zealand’s most powerful banker, said he was “very pleased” with the level of the currency.
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So how can today’s dollar be different to yesterday’s one, and why would Orr be chuffed that it is now buying less?
A free floating exchange rate
New Zealand, many leading economies, has a free floating exchange rate, meaning it moves up and down in value depending, in the most simple terms, on whether there are more buyers than sellers.
There are plenty of both. Billions of New Zealand dollars are traded every day, often by investors who will never come here or buy goods from here, but who trade currencies purely as an investment.
So why does it matter?
The strength of the currency, or the exchange rate, has a direct influence on the price of goods we buy and sell from overseas.
Take, for example, the dairy sector. If a tonne of milk powder was worth US$5000, before Thursday’s interest rate announcement, that would have been worth around NZ$7407.
But by Friday afternoon, the same tonne of milk powder would have been worth $7575. Across the entire sector, a sharp drop in the dollar could mean that New Zealand’s dairy products could be worth hundreds of millions of dollars more in local currency.
So is a low dollar good?
Not for everyone. Say you wanted to buy a smartphone from the US, costing US$999 (assuming for a minute that the manufacturer will allow you to import it). Before Thursday’s announcement, that phone would have cost you about NZ$1480, but by Friday afternoon, the cost would have risen to $1513.
While the impact of a lower dollar can take time to filter down to prices on the shelves, ultimately a lower dollar means the price of all imported goods will go up. In the case of goods like petrol, the price can change within hours of a sharp currency movement.
Why would the governor of the Reserve Bank be pleased that I am paying more?
A lower dollar is generally good for critical parts of the economy: exporters and will see them invest more and take on more employees. A lower dollar also makes New Zealand a more attractive destination for tourists, as when international visitors come here, their money goes further, encouraging them to spend more. It can also have an impact on New Zealanders’ decisions.
If a holiday on the Gold Coast becomes more expensive (and it has – the New Zealand dollar is now buying less than A$90c for the first time this year), a Kiwi holiday marker may choose to spend a week in Queenstown instead, spending their money at home.
Why did the dollar fall on Thursday (and Friday)?
When speculators buy New Zealand dollars, they often do so because New Zealand’s interest rates are high relative to other countries. This means that when interest rates in New Zealand are cut, the dollar tends to fall, while when interest rates are raised, the dollar tends to rise in value.
The unusual thing about Thursday, is that the Reserve Bank didn’t cut interest rates at all. In fact, it said interest rates were unlikely to be moved up or down until well into 2020.
So why the sudden drop?
Currency speculators tend to take a view on what is expected to happen in the future. Before the Reserve Bank announcement, most bank economists expected interest rates to begin increasing some time in 2019, which all else being equal would push up the value of the kiwi eventually.
Now, not only do economists see that as less likely, there is a growing chance Orr will cut interest rates if the economy does not grow, so speculators may have sold the New Zealand dollar on the expectation that it would fall.
Where will the kiwi go from here?
Anyone who claims to know what will happen in currency markets should probably try it for a living. They are notoriously hard to predict.
That said, it seems the outlook for the New Zealand dollar is considerably weaker than it was a few months ago. On Thursday the economics team at Kiwibank slashed their forecasts for the New Zealand dollar over the next year.
Previously the bank thought the New Zealand dollar would be buying US69c by the end of the year, but now it expects the dollar to drop to US65c. By the middle of 2019 Kiwibank sees the New Zealand dollar buying US63c.
Apart from a few weeks in 2015, the New Zealand dollar has not been that low against the US dollar since 2009.