Putting the exchange rate fall in historical context

New Zealand’s exchange rate has fallen quite a way in the last few months. The fall was most dramatic from late April to the start of July, when the Reserve Bank’s TWI measure fell from just over 80 to just over 70, a fall of around 12 per cent. Using monthly average data the fall from April to July was almost as large as any three-month fall we’ve seen in the 30 years New Zealand’s exchange rate has been floating.

twi 3 month changes

But sharp as that fall has been, the total fall in the TWI so far still looks only moderate by the standards of past corrections in the New Zealand dollar. In this chart, I’ve gone back a bit further. The new Reserve Bank TWI data only go back to the start of 1984 at present, but using the BIS indices we can go back another 20 years, to give us just 50 years of data.

TWI largest falls

The first three adjustments were discretionary devaluations, two (1967 and 1975) in response to sharp falls in the terms of trade, and the last associated with the change of government in 1984. As I noted a couple of weeks ago, the fall in the exchange rate so far is similar in magnitude to the short-lived sharp fall in the first half of 2006, when a “growth pause” (still showing in the data as no real GDP growth from 2005Q2 to 2005Q4) sparked expectations of forthcoming cuts in the OCR.

Graeme Wheeler has been using the slightly odd terminology that the exchange rate “needs” to come down and I have already commented earlier on that.  He seems to have in mind some sense of an exchange rate which would stabilise the ratio of NIIP/GDP.  But it is not entirely clear why he thinks the exchange rate is likely to actually fall further. After all, he has been openly disagreeing with market commentators who think the OCR might need to fall to 2 per cent, suggesting that he doesn’t see that the need for the OCR to fall much further. Recall that the falls in the OCR he seems to be envisaging will be tiny when compared to previous policy rate cycles here and abroad. His story seems to envisage that perhaps last year’s OCR increases will be fully reversed, but no more –   but previous easing cycles have involved multiple hundreds of basis points moves.  And, on the Governor’s rather upbeat story, we might reasonably expect the negative NIIP position to widen, to act as the buffer for some of the loss of national income, over the next year or two.

niip to gdp

After all, in the last few years, the NIIP/GDP position has been less negative than it had been for most of the last 25 years (through some combination of the offshore insurance claims resulting from the earthquakes, not yet fully spent, and the high terms of trade). On his story why should we expect much more? If he is right about New Zealand’s monetary policy outlook, many in the market will be surprised and, if anything, the TWI might rise.

But I’m sceptical of the Governor’s story about the New Zealand economy and prospects for domestic monetary policy. When I filled in the Bank’s Survey of Expectations last week, I wrote down a prediction that implies an OCR below 2 per cent by this time next year, and I wondered afterwards if my number was low enough yet. I don’t think anything that weak is yet priced into the central market view. If so, most likely the TWI will move quite a bit lower yet.   Heightened periods of risk are also often bad for New Zealand’s exchange rate –  no one has to hold New Zealand dollar assets when times are risky –  and markets still seem remarkably relaxed about China and the euro-area as sources of economic and financial risk.

Finally, recall that the TWI fell to the lowest level in the last quarter century in 2000, the last (and only) time since liberalisation when US short-term interest rates matched those in New Zealand.  At the 2000 trough, the TWI was some 30 per cent lower than it is today.

4 thoughts on “Putting the exchange rate fall in historical context

  1. Hi Michael,

    Very interesting reading and enjoying your blog!

    One issue that I’m confused about is that the RBNZ is forecasting inflation etc to be at it’s mid-point next year? Where exactly is this going to come from, as if we look to things like current market pricing for Oil (basis Oil being a major driver of inflationary pressure), you are looking at not being far off new low’s (year and multi year) for Brent and West Texas Crude?

    So even with the decline in the currency as you state above, with the Oil price dropping should inflationary pressures not be mitigated as one would imagine? Further I would also think that a lot of firms out there would be reluctant to push up prices, when you are looking at a slackening of demand basis Dairy and high point of Chch rebuild occurring etc.

    In short, what are your thoughts on where/how inflation will start to kick off in NZ?



    • Grant

      I touched on exactly that issue here https://croakingcassandra.com/2015/07/30/what-does-the-governor-say-to-the-unemployed/ As I note, the Bank, rather naughtily focused on headline inflation (rather than core measures), and even then ignored their own research suggesting that any inflation that flows from a lower exchange rate depends a lot on what causes the fall. At present, the slump in global commodity prices has the feel of something that will mean we see very little rebound in CPI inflation in the next few quarters. The concern some of us have is the Bank’s slow awakening to the need for a lower OCR will mean that we end up next year not just with low headline inflation but – more concerningly – with core inflation and inflation expectations dropping away even further.


  2. Thx Michael,

    Yes – I do wonder if the RBNZ next year will be left with inflation well under their estimates and they will then be chasing the market with cuts to the OCR.

    I don’t think it unfair to expect the RBNZ to be more pro-active on the OCR front, when realistically there is little danger of inflation picking up and even if it did, that would not necessarily be such a bad thing for one or two quarters.



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