Kiwi may crash to earth

Last year the New Zealand dollar stretched its legs into new territory against all of its key trading partners.

Against the US dollar it hit a fresh post float high of US74.65c in March.

On a trade-weighted basis -- measuring the unit against those of New Zealand's top five trading partners -- the Kiwi last month toyed with an intraday high of 74.54, easily its highest level since it stopped being a controlled currency in 1985.

The local unit also topped A95c and touched eight-year highs against the euro, Japanese yen and sterling, prompting a call of: "nothing seems to be stopping this train", from Bank of New Zealand currency strategist, Sue Trinh.

At its peak in March, the Kiwi was a whopping 70 per cent higher than when it was freely floated on March 4, 1985 at US44.4c.

Even at its low for the year, around US67c in July, that still signified a 72 per cent gain since it dipped to an all time low of US38.95c in September 2001. At its March high it was 92 per cent stronger than in 2001.

Driving the craze was New Zealand's irresistibly high official cash rate (OCR) -- which strode higher three times this year, twice in quick succession late in the piece, as Reserve Bank governor Alan Bollard tried to put a lid on the rampant housing market and spiralling inflation.

At 7.25 per cent, the official interest rate is easily the highest in the industrialised world.

The high OCR saw demand for eurokiwis and uridashis -- New Zealand dollar denominated bonds sold to European and Japanese investors -- rocket to a staggering $25.3 billion during the year. That is more than the cumulative issuance seen in the years 1999-2004, and had a powerful effect in terms of underpinning the Kiwi.

Currency markets generally follow the laws of gravity, however. What goes up, must come down. With economic fundamentals like a towering trade deficit -- tipped to deteriorate to as much as 10 per cent of GDP, and a slowing growth profile, the New Zealand dollar could fall as sharply in 2006 as it rose last year.

"There are risks that the prospect of a sharp economic slowdown in New Zealand will start to dominate thinking in international markets, which will keep the New Zealand dollar under the hammer," BNZ's Ms Trinh said.

"There are few, if any, local forecasters expecting the New Zealand dollar to be higher than current levels through 2006."

Looming large on the horizon is the fact that $9 billion and $16 billion of those eurokiwi and uridashi bonds reach maturity in 2006 and 2007 respectively.

There is no way of knowing for certain, Ms Trinh said, what the European and Japanese investors will do when that happens. They have two choices: roll it, or take a profit.

With the Reserve Bank signalling it is at the end of its tightening campaign -- which has seen nine rate hikes so far this cycle -- and the European Central Bank likely to continue to tighten in earnest in 2006, the tide against the Kiwi could swiftly turn.

Even Japan, which has had static interest rates for years, is expected to move to change its monetary policy mechanism in 2006.

There won't be any tears in most quarters if the Kiwi undergoes a rapid correction. It will certainly have exporters breathing a collective sigh of relief.

Large sectors of the economy -- manufacturing, forestry, horticulture and fishing -- have already been in recession for over a year, purely because of the exchange rate.

Top sharemarket performers like Fisher & Paykel Healthcare will be hoping the tide turns quickly. The company -- which exports almost all of its production -- has so far avoided too much of a currency headache through hedging. But those hedges, put in place at an effective exchange of US55c, are set to run out in March.

From then, a 1c move in the exchange rate will have a $2m after tax effect on Healthcare's bottom line.

Healthcare in November lifted its first half pre-tax earnings by 10.8 per cent to $47.7m. Of that, $18.9m came from foreign exchange hedge gains.

One event sure to knock the Kiwi off its perch would be the spread of a birdflu pandemic. But nobody wants to be part of that train wreck.

Treasury last month released an estimate that a birdflu pandemic would cost the economy $15-30 billion in the first year and up to $40 billion over four years.

In a report to Government assessing the effects of birdflu on the economy, Treasury said lost output could be of the order of 10 to 20 per cent of GDP in the year that a pandemic occurred.

"The economy would take several years to recover from a shock of this scale and losses could amount to 15-30 per cent of annual GDP over the medium term," Treasury said.

- NZPA