The Reserve Bank of New Zealand believes currency traders are mispricing the nation’s dollar and should take more notice of falling commodity prices even as interest rates rise, Assistant Governor John McDermott said.
“The terms of trade could be at a turning point, we’re certainly getting prices for dairy falling,” McDermott, who heads the RBNZ’s economic department, said in an interview in Wellington late yesterday. “The New Zealand dollar is a commodity currency. It should move and if people were pricing it right, now is the time for it to be moving down.”
The kiwi soared the most in four months yesterday after the central bank raised interest rates for a third time this year and signaled more increases to come. While the strong currency is damping inflation, RBNZ Governor Graeme Wheeler said he expects the exchange rate to decline.
“The financial markets haven’t really moved the currency too much, yet its fundamentals have dropped a bit, and we really want them to focus on that point,” McDermott said. “We were trying to highlight that point. The FX market should be looking at this.”
The New Zealand dollar rose as high as 87 U.S. cents from 85.5 cents immediately before yesterday’s statement. It surged after Wheeler failed to signal a pause in his tightening cycle, which some economists and market participants expected.
While the RBNZ was “resigned” to a jump in the currency after yesterday’s decision, “we think when people go back and reflect about what ultimately really drives this, that hopefully there would be a reconsideration,” McDermott said. “Given what people had talked themselves into, they were always going to view this statement as hawkish relative to their own views.”
The quarter-point increase in the benchmark rate to 3.25 percent was forecast by 13 of 15 economists in a Bloomberg News survey. Banks including ASB Bank Ltd., Deutsche Bank AG and ANZ Bank New Zealand Ltd. brought forward forecasts for another rate move after Wheeler’s statement, saying they now expect the next one in July.
The central bank surprised some economists by maintaining its forecast interest-rate path, indicating another two quarter-point increases over its remaining four policy decisions this year. That’s despite a 28 percent drop in milk powder prices since February and sustained strength in the currency, which Wheeler had warned in May could slow the pace of rate increases.
McDermott said the market failed to realize the RBNZ had already factored lower dairy prices into its thinking in its March projections, and the bank was “genuinely surprised” by the strength of immigration, which in April reached the highest level in more than 11 years. “So net on net, it left everything pretty much as in March,” he said.
McDermott said the RBNZ purposely didn’t signal when it might pause its tightening cycle “because we think it would be counter-productive.” Speculation of a July pause had started to reduce longer-term interest rates and flatten the yield curve, reducing monetary-policy traction, he said.
Unlike three-month bank-bill yields, which have risen in line with the RBNZ’s rate increases, longer-term swap rates have dropped since mid-March. The yield on a 10-year swap fell to about 4.7 percent in May from a 2014 high of about 5.3 percent in January. It rose to 4.93 percent yesterday.
“People were getting a little ahead of themselves,” McDermott said. “There’s a lot of news to come” before the July 24 rate decision, including first-quarter growth and second-quarter inflation numbers, “and we’re going to absorb that before we make that call.” The July decision will be “absolutely” data-driven, he said.
While house-price inflation slowed to 8.2 percent in May from 10 percent in December, the RBNZ is “still worried” there could be renewed momentum in the housing market, McDermott said.
Interest rates “are still low” and if people jump into the market for fear that prices will continue to rise, “you get expectations-driven dynamics,” he said. “That would be a really bad outcome.”
There’s a 61 percent chance that the RBNZ will raise rates again in July, up from 30 percent on June 11, according to interest-rate swaps data compiled by Bloomberg.
McDermott said the bank expects to raise its benchmark by another 50 basis points this year and, while its forecasts are always conditional, “it would take more than what we can see at the moment” for it to deviate from that track.
“It’s not impossible to change our path, but it would have to be something else we’re not yet anticipating,” he said. “We want to get interest rates more to a neutral level. This is our base plan. If the data comes in a bit stronger, we’ll push it a bit faster, if it comes in a bit weaker we’ll take more time.”