FX Forecasts: We retain our NZD/US$ forecasts at 0.68, 0.64 and 0.62 on a 3-, 6- and 12-month view. This implies €/NZD at 1.53, 1.56 and 1.53.
Motivation for Our FX View: We see further downside risk to the NZD over the coming year, against the backdrop of ongoing weakness in dairy prices, a further deterioration in NZ’s trade position and broad-based USD strength as the Fed raises rates. On balance, we characterise the risks to our forecasts as skewed to the downside, but are mindful of the relative resilience of NZ domestic demand to date and the risk that there are further delays in the Fed’s tightening cycle.
Monetary Policy and FX Framework: The RBNZ is a flexible inflation targeter. The RBNZ Governor is the sole decision maker on the Official Cash Rate (OCR), and contracted to achieve "future CPI inflation outcomes between 1 per cent and 3 per cent on average over the medium term, with a focus on keeping future average inflation near the 2 per cent target midpoint". The FX regime is a free float. Growth/Inflation Outlook: GDP expanded by a solid +0.9%qoq in 2015Q3, taking the annual rate of growth to +2.3%yoy. Notwithstanding the deceleration in growth from a peak of +4.1%yoy in 2014Q4, the NZ economy appears to be navigating through the dairy-led income shock with some resilience. Nevertheless, national disposal income growth remains weak, lower dairy prices have yet to fully work their way through the economy, and tailwinds from the postearthquake rebuild and prior strength in net migration may start to taper over time. Overall, we expect an extended period of slightly sub-trend growth in NZ, with inflation pressure likely to remain contained for some time on the back of lower oil prices and weak global/tradables inflation.
Monetary Policy Forecast: The RBNZ cut rates aggressively through 2015H2, including its latest round of easing in December 2015. While the RBNZ retains a mild easing bias, its rhetoric is now more balanced and future decisions more data-dependent. In turn, recent activity and survey data have been more encouraging, with the focus shifting to any potential breakdown in inflation expectations. We expect the RBNZ to remain on hold at 2.50% over 2016.
Fiscal Policy Outlook: NZ’s fiscal position remains on an improving trajectory. However, weaker national income growth on the back of low inflation and the weaker terms of trade mean a likely later return to underlying fiscal surpluses than forecast at the 2015 Budget.
Balance of Payments Situation: NZ’s current account deficit narrowed slightly to 3.3% of GDP in 2015Q3, as the services surplus continued to improve and export earnings stabilised. However, as lower dairy prices erode the trade data and as global bond yields rise, we expect to see a re-widening in the current account balance over 2016.
Things to Watch: Outside of US Dollar direction and global dairy price trends, domestically the focus remains on the extent to which weaker incomes undermine confidence, drought conditions intensify, and inflation expectations and broader economic activity break down. Separately, ongoing strength in net migration present an upside risk to growth.
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