Deutsche Bank sees kiwi back up over US70c

10.00am

Deutsche Bank predicts the New Zealand dollar will head back up to US71 cents by the middle of next year.

The bank in its quarterly forecasts predicts the Reserve Bank will hike interest rates on June 10 and probably again in either July or September. That will be underpin the currency although Deutsche chief economist Ulf Schoefisch says that by next year the RB will be easing rates again.

He believes the economy will be slowed by a number of headwinds that will see growth slow to 2.0 per cent around the middle of next year.

Although headline inflation is forecast to touch 2.6 per cent, mainly because of spiralling oil prices, underlying inflation is seen comfortably within the RB's 1-3 per cent target, and Dr Schoefisch questions the wisdom of such decisions.

"Considering the underlying headwinds for the economy, it remains questionable whether the current tightening cycle was needed to prevent medium-term CPI inflation from heading towards the top of the 1-3 target range," said Dr Schoefisch.

"Based on our forecast of underlying CPI inflation remaining subdued over coming years, we expect the RB to start reversing the current tightening cycle during the September quarter of 2005 and to take the cash rate back to 5.25 per cent by the end of next year."

Dr Schoefisch lists the headwinds as supply constraints in the labour market and a slowdown in productivity growth. The resurgence of the dollar would limit export growth while consumption growth and residential construction are forecast to slow as a result of low migration, rising interest rates and the inability of households to borrow more.

Since the middle of last year, the household sector has borrowed, on average, more than $1.1 billion extra per month.

While most people's mortgages are on fixed terms, these will unwind in 16 months and higher interest rates will crimp spending.

House price inflation is seen dropping from 24 per cent last year to 10 per cent in 2004 and zero in 2005.

Buoyant commodity prices will offset exporters' loss of income from the currency rise, but commodity prices are expected to come off the boil.

A weak US dollar due to a burgeoning currency account deficit in the United States is the main reason behind the kiwi's predicted rise and the exchange rate is only expected to appreciate by 4 per cent on a trade-weighted basis. With New Zealand's current account deficit picked to hit 6 per cent of GDP by early 2006, the heat will come out of the local currency.

While household spending will cool fairly soon, business investment will remain relatively strong over this year in response to high levels of capacity utilisation, Dr Schoefisch said.

- NZPA