New Zealand Dollar Falls But Further Downside Limited As Risks Are "Well Priced"

Central bank reforms proposed by the coalition are less drastic than feared and well priced by markets. While the coalition has stepped back from a harsh migration clampdown, it will be pushing ahead with restrictions on foreign property purchases. 

The New Zealand Dollar fell in London Tuesday as traders responded to details of the new government’s plans to reform the Reserve Bank of New Zealand.

New Zealand’s Labour-led coalition government said Tuesday that it will push ahead with a plan to modernise the RBNZ rate setting process and to adapt its mandate into a more growth friendly format.

But risks to the currency stemming from any RBNZ reform are well priced, according to strategists, who have also recently downplayed the impact of reforms on market interest rate expectations. 

“We see limited further decline for NZD/USD over the short-term,” says Derek Halpenny, European head of global markets research at MUFG.

The Pound-to-New-Zealand-Dollar rate was quoted 0.72% higher at 1.9037 in noon trading Tuesday while the NZD/USD rate was down 0.98% at 0.6914.

Previously supposed plans to have the RBNZ take into account the NZ exchange rate, in a more explicit manner, were absent from details of the shakeup revealed by the coalition on Tuesday. 

However, policymakers will soon have to ensure that policy decisions are consistent with returning the economy to full employment.

This was seen during and after the election campaign as something that might result in interest rates remaining lower for longer.

“In the absence of numerical targets for either unemployment or the exchange rate, requiring the RBNZ to account for these considerations is unlikely to make a significant difference to how monetary policy is run as a whole,” says Dominick Stephens, chief economist at Westpac.

Most central banks already take labour market slack into account when setting policy as it is a key input into their inflation forecasts and so a dual mandate that incorporates a more explicit reference to the Labour market may not lead to any real change in policy over the longer term.

“Given the unemployment rate is trending lower and at 4.8% is the lowest since December 2008, a shift in mandate to a dual mandate that incorporates a full employment target is not necessarily a dovish scenario that would greatly alter the short-term direction of monetary policy,” chimes Halpenny, at MUFG.

That said, Labour’s proposals to use fiscal policies as a means of stimulating the economy may mean tweaks to RBNZ policy over the shorter term, and not everybody agrees that risks to the New Zealand Dollar are so benign.

“Even if the RBNZ do not become any more dovish per se due to mandate changes, fiscal stimulus is important in propping up growth next year in the RBNZ’s forecasts, so if it arrives later under Labour’s policies, that could be decisive for monetary policy settings,” says Ben Jarman, a strategist at JPMorgan.

In the context of a slowing economy, any delay to fiscal policies may prompt the RBNZ and others to adjust their growth and inflation forecasts, which might beget a dovish policy response.

“NZD is our biggest short for the week ahead, the model keying off the lackluster dairy auction last week and continued erosion in yield support for the currency,” says Richard Franulovich, a quantitative strategist with the foreign exchange team at Westpac.

The New Zealand Dollar has fallen by 5% on a trade weighted basis since New Zealand First opted to form a coalition government with the Labour Party. Meanwhile, a beleaguered Sterling has risen by more than 7% against the Kiwi since the beginning of the year, with half of this gain coming in the last week alone. 

Possible central bank reform, a hard clampdown on immigration and curbs on foreign ownership of domestic property were among the reasons why markets had preferred a Labour and New Zealand First coalition the most at the September general election.

In the days since a coalition agreement was announced both Labour and NZ First have shown signs of stepping back from their more contentious policies.

An NZ First push to reduce net migration from 70,000 per year down to just 10,000 was the first casualty of coalition horse trading, with the government set to pursue Labour’s policy of reducing net migration by a lesser clip of around 30,000.

“We are already forecasting a substantial reduction in net immigration, from over 70,000 now to around 20,000 by the end of 2020. If immigration regulations were tightened, we would reduce our net immigration forecast even further. In turn, this would reduce our GDP forecast,” says Stephens at Westpac.

The inclusion of exchange rate targeting into the RBNZ mandate has also gone out of the window. But the coalition, under Labour leader Jacinda Ardern, did say Tuesday that it will push ahead with attempts to ban foreign purchases of existing residential property in New Zealand.

“Such changes could have a material negative effect on house prices, but it is far from certain that the coalition government will go ahead with Labour’s plan,” Stephens notes.

The measure is aimed at stemming house price growth and helping Kiwis onto the housing ladder but economists have taken issue with it due to fears it could foreign direct investment.

The extent of tax changes and other fiscal initiatives will also be a key input into the market’s future appraisal of the Labour coalition.

“If the coalition sticks roughly to Labour’s proposed fiscal policy, the changes would be fairly immaterial for ratings agencies and would not lead to significantly higher government bond rates,” Stephens writes.

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