INSIGHTS

The other week I had a client ask what the optimum level for the NZ dollar was. He owns an export business so I knew the answer he was angling for - the lower the better.

Indeed, many parts of our economy benefit from a weaker currency. However, it’s more complicated than that as we also purchase a lot of goods, services and raw materials from overseas.

The currency has been kind to exporters lately. On a trade-weighted basis, it’s down more than eight per cent from its 2021 highs, despite being some five per cent above its 25-year average.

The biggest fall has come against the US dollar. We’re down ten per cent this year, and 17.2 per cent below last year’s peak, having fallen from US$0.74 in early 2021 to US$0.62 today.

That’s been a healthy tailwind for the export sector, making us more competitive and pushing up the local price of our goods. It’s one reason this season’s Fonterra payout will be the highest ever, despite a volatile ride for global dairy prices.

Investors have also benefited from the weaker currency. The MSCI All Country World Share Index has fallen 15.2 per cent over the past 12 months, but when the lower NZ dollar is accounted for this decline moderates to a much more modest 4.4 per cent fall.

It’s not all good news though. While exporters and share investors have been helped by a weaker currency, consumers and borrowers haven’t.

The other side of the coin is that a weaker NZ dollar leads to higher prices for imported goods. This includes fuel, raw materials and everything else we source from offshore.

This came through loud and clear in Monday’s inflation report. The headline inflation rate of 7.3 per cent was the highest since 1990, while the tradables component (which essentially measures imported inflation) was even stronger with an 8.7 per cent increase.

A lower NZ dollar is contributing to this higher inflation rate, which means we’re staring down the barrel of more interest rate hikes this year.

In theory, this should all be self-regulating. Higher interest rates should push the currency up, improving our buying power overseas and reversing some of that tradables inflation.

Problem is, currency movements are all relative and many other countries are raising interest rates too.

It’s difficult to predict where the currency is going over the next few years. The NZ dollar is usually tied to risk sentiment, so it’s likely to rebound if the global backdrop improves, or fall further if the outlook darkens.

In contrast, the US dollar tends to strengthen during times of uncertainty and lag when the mood is more upbeat. The greenback has benefitted from cautious sentiment in 2022 and it's been strong against all currencies, not just ours.

As investors, these are things to be mindful of, although currency moves shouldn’t drive our investment decisions. It’s more important to focus on great businesses with good prospects, wherever they happen to be.

The same goes for businesses, who can do their best to manage currency risks despite having no control over them.

There’s no perfect level for the NZ dollar. Ideally, we want it low enough to keep our exporters competitive but strong enough to maintain our purchasing power in the global marketplace.

A weaker currency is a double-edged sword, and we’re arguably somewhere near the sweet spot right now.