Exchange rate risk easing

  • Opinion
  • February 4, 2016
  • Roger Kerr
Exchange rate risk easing
Kerryn Smith

If the Kiwi dollar appreciates too rapidly or remains at elevated levels for prolonged periods against the US dollar, the incomes, profits and jobs in our key export industries suffer. On the other side of this, rapid depreciation of the NZ dollar leads to price increases on imported consumer goods and increases inflation.

Households reliant on export industries for their jobs prefer a lower currency value; although every household prefers a stronger NZ dollar with appliances, furniture, overseas holidays, motor vehicles and clothing, as these expenses are generally lower in price as a result. Over the last four years, consumers have enjoyed constantly lower prices for these items as the NZ dollar held above 0.8000 to the US dollar due to high dairy export prices and a weaker US dollar after the Global Financial Crisis.

Unfortunately for consumers, the currency world has changed dramatically over the last 12 to 15 months. The NZ dollar has plummeted 30 percent from highs of 0.8800 in June 2014 to lows of 0.6250 a few weeks ago. Prices of imported consumer goods are already increasing due to the higher NZ dollar cost to importers and retailers as a result of the exchange rate depreciation.

The chart below confirms a nine month time lag from NZ dollar and US dollar exchange rate movements is linked to changes in household appliance prices in the shopping centres. The close correlation shows appliance prices increasing by over six percent in the coming months, as retailers pass through their higher imported costs. These impending price increases for appliances will be mirrored across all imported products purchased in US dollars.

As a consequence of this, the Reserve Bank of New Zealand is forecasting the annual inflation rate to increase sharply over coming months from the current 0.4 percent annual rate to over 2.00 percent (their target rate) by April or May next year. Part of the explanation for the stretched-out time lag between currency depreciation and price increases is the foreign exchange hedging activities of importers and retailers. There is no question that importers and retailers hedged to higher levels and for longer periods than they normally would when the NZ dollar and US dollar rate was above 0.8000 in 2014. However, that legacy currency hedging is now running out and current imports are being priced from a 0.6500 NZ dollar and US dollar exchange rate.

The future direction and value of the NZ dollar is always a matter of much debate and conjecture. What has become apparent in recent years is that the major determinant of the NZ dollar and US dollar exchange rate movements is the price gyrations of our major export commodity, which is wholemilk powder. The dramatic plunge in wholemilk powder prices in August to US$1,500/MT sent the Kiwi dollar down to lows of 0.6250. Equally dramatic over recent weeks has been the rapid recovery upwards in wholemilk powder prices to US$2,800/MT.

It’s of no great surprise that the NZ dollar and US dollar exchange rate has bounced upwards as well, to highs of 0.6880. Provided wholemilk powder prices can sustain their gains over coming months, it appears that the Kiwi dollar will bottom out in the 0.6300 to 0.6500 area, meaning importers and retailers appear to be facing reduced risk levels of further NZ dollar depreciation going forward.

This story originally appeared in NZRetail magazine issue 741 December 2015 / January 2016

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