Fed saves NZ dollar from real shakeout

Fears of the dollar resuming its spectacular first-quarter plunge have receded since the US central bank last week set the scene for a softer greenback over the coming months, providing the local unit with a parachute.

Currency strategists now expect the kiwi to trade slowly but steadily lower for at least six months, barring nasty shocks in domestic economic data or an earlier than expected Reserve Bank interest rate cut.

The kiwi dived by almost 12 per cent over the first three months of the year before recovering a little to trade in a two cent range around US63c between mid April and mid June.

However, last month's poor local trade data, combined with a resurgent US dollar, pushed the kiwi below US60c for the first time in three years. That kindled expectations the local unit was again headed sharply lower.

ANZ economists had last week highlighted the possibility that should the US Federal Reserve indicate it may push its key interest rate past 5.5 per cent, the kiwi could plumb levels below US50c over the next 12 months.

A higher Fed rate would narrow the kiwi dollar's interest rate advantage over the greenback and make it less attractive to currency investors.

A second big fall this year combined with the first would have been "the most aggressive shakeout in the NZ dollar's post float history".

But the Fed raised its funds rate to just 5.25 per cent on Thursday - as expected by most in the market - and came out with a relatively dovish statement, saying further rate hikes would depend on data. The commentary halted the rally the greenback had been enjoying in preceding days.

As a result, the kiwi bounced back over the US60c mark and closed at US60.86c locally on Friday.

ANZ was now expecting to see the kiwi at between US53c and US55c in the next six months and perhaps as low as US52c sometime in the next year, "but the time's not right for that move to eventuate right now", said ANZ head of markets John Body.

"A combination of Fed funds at 6 per cent and an earlier RBNZ easing cycle could have created that sort of violence, but given that we are probably close to the top of the US rate hike cycle, US52c is a big enough overshoot and I struggle to see how we could get the conditions for anything below that, barring some kind of domestic calamity."

The local unit's rebound from last week's three-year low of US59.61c could extend as high as US63c said Body. But BNZ currency strategist Danica Hampton believed the dollar's bounce would top out at US61c at most.

"The bearish bias is intact and over the medium term we see the New Zealand dollar trending lower," she said.

BNZ saw the kiwi at US57c in six months and bottoming out at US55c to US54c in the latter part of 2007.

The kiwi dollar remains underpinned to some extent by the official cash rate which at 7.25 per cent, is one of the highest in the developed world, although with other economies now well into tightening cycles, that advantage is diminishing.

This year has seen speculation that the kiwi could tumble as its shrinking interest rate advantage motivates offshore investors to bail out of New Zealand dollar-denominated assets.

But Hampton said there were few signs of that. During June, nearly $1 billion in eurokiwi bonds and their Japanese counterparts, uridashis, matured but new issuance more than made up for that.

Westpac senior economist Nick Tuffley also expected a gradual decline by the kiwi as did Royal Bank of Canada's (RBC) Sydney-based currency strategist Sue Trinh.

She forecast the kiwi at US59c by the year's end and US57c mid 2007.

"What would be required to give the kiwi a kick lower is the RBNZ to begin its easing cycle and we don't forecast that until the first quarter of next year."

Likewise, ANZ's Body too believed a Reserve Bank rate cut would be the most likely trigger for a significant move lower.