New Zealand economy continues to face downside risks, RBNZ ready to lower rates to keep NZD weak

Significant risks on the downside are still faced by the New Zealand economy. Solid headwinds are caused on the global front by the heightened volatility in the financial markets and subdued outlook of China’s economy. This is impacting New Zealand’s export outlook. Also, the Reserve Bank of New Zealand is worried regarding the current demand related to downward pressure on prices of commodity. Persistently low price of milk, especially, is impacting the New Zealand economy as this exerts tremendous pressure on the country’s terms of trade.

The New Zealand’s domestic dairy sector is facing troubles due to low milk prices. The dairy sector accounts for more than one quarter of exports. Excluding the dairy sector, sentiment is relatively good. High immigration levels, low interest rate, persistent strong building sector activity are driving domestic demand.

But inflation is not gaining from that. In Q4 2015, inflation markedly disappointed. It has continued to stay below the central bank’s target range of 1%-3% since the end of 2014. The central bank has become vigilant due to the constant downward risks to inflation due to lower commodity prices and stronger New Zealand dollar. The RBNZ has cut its interest rates by 75bp last year. It also cut rates further by 25p in March to 2.25%. It is expected to have lowered its rate again in March due to stronger NZD. The central bank is prepared to further ease monetary policy if attaining the inflation target is at risk.

The trade weighted NZD traded over 4% more than the RBNZ’s level assumed in its December projections. This suggests that the outlook of inflation is at risk. The rising New Zealand dollar is exerting pressure on import prices and consequently on inflation of tradable goods. Therefore, the Reserve Bank of New Zealand has mentioned that it will not stand a stronger currency and will avert an appreciation if required by lowering rates.

“In the short term, the kiwi is expected to be at low levels; however, it is likely to sustainably appreciate against the USD in the medium to long term, and to gain against the euro as the ECB will continue easing monetary policy in the near future to keep the euro weak”, said Commerzbank in a research report.

Meanwhile, the US Fed has stated explicitly that it will raise its interest rate at quite a slow pace to stop the US dollar from gaining markedly. In the mean time, the New Zealand economy and inflation are expected to rebound enough for the central bank to stand a stronger currency.