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Look Out Below! New Zealand Dollar Falling

By Sean Hyman   |   Friday, 01 Aug 2008 09:56 AM

New Zealand's dollar has some tough months, and probably a tough year, ahead.

For the longest time, it raised rates and has held the title of having the highest interest rate of any triple-A rated country. So, naturally, money ran to take advantage of this very high yield, since the risks appears to be so low with such an awesome credit rating.

So, for years now, there was nothing not to love and no reason to be out of this currency.

Well, today is a different day. Recently, the central bank surprised economists by lowering interest rates for the first time since July 2003.

Currency investors around the world are taking note. As small countries do, New Zealand usually has to cut rates rather quickly once they start cutting, because the economy is so quickly affected.

I would expect to see another 50 basis points shaved off in addition to that 25 basis point cut. I think you may see it at the end the year at 7.50 percent. Another cut could come as soon as the Sept. 11 meeting.

Why cut? Any time your economy starts to slump, the way to give it a shot in the arm is to cut the cost of money, which lowers rates on loans and credit cards and makes it easier for both companies and consumers to borrow.

Tourism spending growth is already slowing under the highest exchange rates since the early 1980s and the highest interest rate in years. This combo has certainly discouraged tourism. Why go there when the exchange rates are so high, especially since in one year they will be significantly lower, most likely?

So, with tourism down; the economy contracting 0.3 percent in the first quarter; a drought; a slumping housing market in its fourth month of declining sales and prices; slumping retail sales; the lowest consumer confidence readings in years; and rising credit costs … why wouldn't the country continue to slump? It has everything going against it right now.

All of this combined will probably cause New Zealand to see its first recession since 1998. Many economists consider two back-to-back quarters of negative GDP growth to be the sign of a recession. We have one quarter of negative GDP already, and I'm predicting another one to follow. However you want to call it, that puts them into a recession.

All of this will bring the currency down from its present level of 0.7425 on the NZD/USD pair to around 0.7200 in the coming month or two. I also believe you will see this NZD/USD exchange rate drop to around 0.6000 before the decline is over. It could drop more, but I think you will see it fall at least this far before all said and done.

That said, there will be a lot of shorting opportunities for long term currency investors and short term traders alike. While the NZD/USD exchange rate has fallen 2.6 percent this week, there is much more to follow. This is just the beginning.

Inflation is still high and will remain that way for quite some time. However, the central bank expects that the slowdown in the overall economy will drag down inflation over time. I feel they are right in this assessment as well.

Nevertheless, I do expect a near-term rally over the upcoming days to weeks as the pair consolidates a bit before making its next major move downward. In fact, comments from their central banker, Alan Bollard, may even encourage a near-term consolidation.

Quoting him: "Provided that the outlook for inflation continues to improve and there is no excessive exchange rate depreciation, we could expect to lower the official cash rate further."

This is their attempt to have an orderly decline and not a massive sell-off in the currency. And with these comments, that is what Bollard will likely get.

So, as the New Zealand economy remains weak for at least the remainder of 2008, expect more rate cuts and currency depreciation over time as the fundamental situation in their country continues to erode.

Even the U.S. dollar will hold its ground against the New Zealand dollar while the New Zealand currency continues its fall, bringing the NZD/USD exchange rate quite significantly lower by year's end.

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SeanHyman
New Zealand's dollar has some tough months, and probably a tough year, ahead. For the longest time, it raised rates and has held the title of having the highest interest rate of any triple-A rated country. So, naturally, money ran to take advantage of this very high yield,...
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