Room yet for kiwi to fly

By ELLEN READ

As the New Zealand dollar pushes through 50USc exporters are beginning to scowl - the stronger the local currency, the less they get for the products and services they sell overseas.

But taking a longer-term view, is our currency really that high?

The easy answer is that it depends. A more complicated version - which still doesn't lead to a firm conclusion - is as follows ...

The average level of the kiwi against the US dollar over the past 10 years is 55USc, says Westpac currency strategist Jonathan Bayley. Viewed like this, the local currency is relatively low at the moment, although Bayley notes that the 10-year average includes a period of frantic foreign direct investment into New Zealand, prompted by asset sales and deregulation in 1994, which drove up the kiwi.

Another way of measuring the dollar's strength relies on the rule of thumb that during any currency cycle the dollar falls and rises about 20 per cent above and below its average.

So, if the kiwi's low of 38.98USc, reached in October 2000, marks the bottom of the present cycle, then the average should be 48.50 USc and the high point is some way off at 58.50USc, says Bayley.

Viewed this way, the currency is expensive at the moment but still has some way to go to reach its cyclical peak.

Viewed yet another way, the trade weighted index, which measures the New Zealand dollar against the currencies of our main trading partners, was at a 2 1/2-year high of 57.31 on Friday.

Is that high or low? About neutral, according to last week's monetary policy statement from Reserve Bank Governor Alan Bollard.

Throw in a few more numbers and the situation fails to become much clearer. Since it floated on March 4, 1985, at 43.70USc, the kiwi has hit a high of 71.75USc (November 1996) and the 2000 low of 38.98USc.

So at its current level of about 50USc, the dollar is either cheap or expensive, depending on your agenda and how you look at it.

Given that, what are the implications of the currency's present value and where is the kiwi likely to go, relative to the US dollar (the key rate to keep in mind, given that most international trade is denominated in greenbacks)? Again, the easy answer is that it depends. Sure, exporters are grumbling but the flip side is that importers are paying less and consumers are enjoying the benefit, petrol price cuts being one recent example.

Although New Zealand traditionally runs a huge current account deficit, this year we were the closest we had been for 13 years to paying our way in the world.

The current account deficit - the difference between what we earn from the rest of the world through trade, tourism and investment and what the rest of the world earns from us - shrank to $2.7 billion in the year ended March (the previous year it was $5.3 billion, and $7.1 billion the year before that).

The weak local dollar helped the deficit shrink so it follows that the opposite will occur as the kiwi strengthens.

New Zealand will also look less desirable as a tourist destination, while foreign travel becomes cheaper to New Zealanders.

Analysts and strategists are reluctant to say what represents "fair value" for the kiwi. However, most expect it to rise over the coming year. A Reuters poll of 11 banks, which asked where the dollar would be by September next year, came up with answers ranging from 48USc to 56USC, with an average of 52.30USc.

There are five main factors that push the New Zealand dollar up and down:

* Relative growth levels. Other things being equal, if New Zealand's economy is growing strongly, compared with other countries, the kiwi will tend to rise, or vice versa if local growth is lagging the rest of the world.

* Risk aversion. In times of uncertainty, investors tend to be wary of "peripheral" currencies such as New Zealand's.

* The strength or weakness of the US dollar. If the US dollar is stronger, for example because its economy is performing well, then the kiwi is weaker and vice versa.

* Technical levels. Traders study market activity and use past movements to predict what will happen.

* Interest-rate differentials. New Zealand interest rates are higher than they are in the US, which makes it attractive to investors, driving up the kiwi. The Reserve Bank's decision last week to leave the official cash rate unchanged, despite falls in other parts of the world, is seen as one of the reasons for the kiwi's latest rise.

Global growth and risk aversion were the main drivers in the first three months of the year. In April and May there was a shift to US dollar weakness and the ensuing interest-rate differential.

Since then the focus has expanded to include relative growth levels.

Asked what will drive it from here, strategists say it's a US dollar story.

That currency is overvalued - as shown by America's huge current account deficit - and has nowhere to go but down.

As that happens, in true seesaw fashion, the kiwi will go up, even though the fundamentals driving it - relative interest rates and growth - will diminish in influence over the next 12 months.

The US Federal Reserve has signalled an end to cuts in interest rates, so the yield differential will diminish. Although our domestic growth is strong, there are concerns about agriculture.

While the kiwi has gained around 21 per cent against the greenback this year, it has also made ground against the Australian dollar, rising 10 per cent.

Its gains against the Australian dollar reflected the relative interest rates in the two countries and their economic fundamentals, both of which favour New Zealand.

But whatever the market says, Dr Bollard is only modestly bullish about the New Zealand dollar's prospects of a further rise against the US dollar.

"We have got into our forecasts a projection that a medium-term real trade-weighted index equilibrium level for the kiwi is roughly 58, which is roughly US52c," he said last week.

"We are already a bit higher than when we started the forecasts so if you look at our predictions, you've got as a working upside another one or two cents."

This is not a forecast of what Bollard believes will happen, it's just what the central bank sees as an "equilibrium" rate for the kiwi - neither high nor low.