INSIGHTS

The NZ dollar has rebounded strongly from the weakness of September. While this probably isn’t great news for our export sector, it will lend a hand to the Reserve Bank in its fight against inflation.

Over the last week, the currency has risen as high as US$0.64.

It’s still 6-7 per cent down from where it started the year, and about three per cent below its 25-year average of US$0.66.

However, it’s recovered some 15 per cent since falling to US$0.55 eight weeks ago.

Apart from one day during March 2020 (when sentiment was extremely negative in the depths of the pandemic) that was the lowest we’d seen since the GFC in 2009.

Currency movements are always a double-edged sword for a small, export-focused country like New Zealand.

Our agricultural sector and other export industries benefit from a weaker NZ dollar. They become more competitive on the global stage and local incomes get a boost.

We also look more attractive to tourists, as their money goes further when they get here.

On the other hand, costs rise for everything we purchase from overseas. That includes many consumer products and things like fuel, which tend to filter right through the economy.

When calculating our inflation rate, Statistics NZ groups goods and services into what they call tradables and non-tradables.

The former covers goods and services that are either imported or in competition with foreign goods, which means exchange rates affect their prices.

Tradables represent about 40 per cent of the inflation basket, with categories like food, clothing, furniture and transport particularly sensitive to currency movements.

Because of this, currency and interest rates can often move in tandem.

When interest rates are rising, demand for the NZ dollar increases as it’s offering a higher yield. That improves our international buying power and keeps a lid on imported inflation.

This can make the Reserve Bank’s job slightly easier and mean interest rates don’t need to go quite as high, which in turn can act as a handbrake on further currency strength.

The ebbs and flow we’ve seen in recent months have been driven by numerous factors.

The NZ dollar is a cyclical currency, which means it tends to follow the economic cycle, rising when sentiment is upbeat and falling during times of uncertainty.

The US dollar is the opposite, and when people are worried about the outlook they flock to the safety of the greenback.

This has been the case for much of this year, and it helped push the US dollar to a 20-year high. The fact the US cash rate is now close to four per cent, the highest since 2008, has provided an added tailwind.

More recently, the hawkish tone from our Reserve Bank has seen the NZ dollar recover some ground.

It’s been about US dollar weakness too, as markets have become a bit more optimistic. During November, the US dollar index fell five per cent, its worst month since 2010.

Currencies are notoriously difficult to forecasts over short timeframes, although I suspect the fortunes of the NZ dollar in the coming months will be closely linked to global economic conditions.

If the positive tone continues, we’ll probably drift higher. If another bout of uncertainty hits, we’ll head down sharply.

As for its impact on inflation, a stronger currency alone won’t solve all our problems. However, every little bit counts and the Reserve Bank will be quietly comforted we’re back in the 60s.