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AUD and NZD: Striking similarities – HSBC

Research Team at HSBC, notes that over the course of the year, the AUD and NZD appear to have followed a similar narrative as both countries have strong growth, exuberant housing markets and below target inflation.

Key Quotes

“Consequently, the RBA and RBNZ have eased policy rates to record lows in an attempt to drive inflation higher. Both central banks view the exchange rate as a “source of uncertainty” in reaching inflation targets. While the RBNZ has explicitly stated that “a decline in the exchange rate is needed”, the RBA has thus far only expressed concerns about the AUD should it appreciate further still. This likely reflects the fact NZD has broadly outperformed AUD.

A weaker currency is desired by both central banks to help lift inflation and encourage domestic economic rebalancing. But another angle to consider is external rebalancing. Australia and New Zealand have persistent current account (CA) deficits: some of the widest CA deficits in the G10. In order to successfully rebalance these external sectors, both currencies may need to fall from their present levels.

AUD a piece of the puzzle

In theory, a depreciating AUD should improve the current account position: foreign goods become more expensive to domestic consumers and domestic goods become cheaper to foreign consumers. Since early 2013 the AUD has fallen by around 25% on a trade-weighted basis. But until recently this has coincided with a widening of Australia’s CA deficit. A weaker AUD does not seem to have boosted export growth. Possibly any exchange rate effect was offset by falling commodity prices over this period. Yet the commodity price collapse appears to have bottomed out and exports growth continues to flirt with negative territory.

The RBA expects net exports to make a positive contribution to growth over the period ahead, “supported by the earlier exchange rate depreciation” according to the August meeting minutes. On 6 September, the latest data for Australia’s current account showed the deficit narrowing – an indication that the exchange rate effect may be filtering through. But the currency will remain an important component in rebalancing Australia’s external accounts.

A weaker NZD is necessary

New Zealand faces a similar predicament. The NZD fell significantly on a trade-weighted basis over the course of 2015, before moving higher recently. There has been a subtle improvement in the CA position. This may be partially due to 2015’s fall of the NZD. Yet since September last year, the NZD trade-weighted index is up by 13%. New Zealand may require a weaker Kiwi to help the current account continue to rebalance.

The RBNZ is not happy with the current level of NZD. In August’s policy statement, the RBNZ stated that “the high exchange rate is adding further pressure to the export and import-competing sectors” before going on to explicitly mention that “a decline in the exchange rate is needed”. Inflation in New Zealand remains below the RBNZ’s target range of 1-3%. Tradable inflation is running at -1.5%, highlighting the challenge of a strong NZD.

Conclusion

We believe both the AUD and NZD need to fall from their current levels. While the AUD has weakened considerably since 2013, a further fall may be necessary to prompt export growth, sustaining the recent improvement in the CA position, and pull inflation higher. New Zealand’s CA deficit is narrower than that of Australia’s. Yet the recent rise in the Kiwi threatens New Zealand’s external rebalancing and the RBNZ’s ability to reach its inflation target. With both central banks also exhibiting a preference for a weaker currency, we see both AUD and NZD falling through the rest of 2016.”

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