Barack Obama's re-election as United States President means quantitative easing will remain in vogue in the US. While some perceive that quantitative easing weakens the greenback, we believe the reasons behind it, stuttering growth in the US and relatively rosy New Zealand growth prospects, will keep the Kiwi dollar high.
What is quantitative easing?
Usually when central banks want to stimulate economies, they lower the interest rates at which they provide cash to the banking system. This promotes lending to households and businesses that then increase spending, generating economic activity. Since the Global Financial Crisis, some central banks have reduced interest rates to zero to try to jumpstart their economies. Alas, even this has not worked! Some have turned to unconventional monetary policy, such as quantitative easing (QE). Central banks buy financial assets they do not normally buy, including long-term government bonds, company bonds, shares or even commercial loans. The intent is to lower long-term interest rates, stimulating bank lending and boosting the economy.
During Obama's first term, the US Federal Reserve carried out three rounds of QE. His re-election gives the chairman of the Federal Reserve, Ben Bernanke, the green-light to continue. In contrast, the Republican candidate, Mitt Romney, was a vocal critic of QE and a win for Romney would have seen greater scrutiny of QE.
QE has not caused inflation to date ...
Some commentary claims QE does more harm than good, driving down exchange rates, creating undesirable inflows of capital into other countries and generating inflation.
This is currently driving investors toward assets viewed as inflation-proof - gold, shares, property - or to currencies where central banks still have conventional monetary policy tools to fight inflation - namely, the Aussie or Kiwi dollar.
This perception might be true in normal circumstances. Inflation can arise from rapid growth in the money supply and commercial banks' reserves have expanded significantly with QE. But these are not normal times - precisely why the US has been forced into QE.
... nor undermined the US dollar
The additional reserves have helped the commercial banks stabilise their balance sheets, but, crucially, much of the money has not been on-loaned to businesses or households.
Accordingly to date, QE has done little to spur economic growth, or inflation. Nor has it driven exchange rates, with the US dollar at similar levels to four years ago.
The Federal Reserve hopes the latest round of QE will be different. The September round focussed more on promoting bank lending, including purchases of mortgage-backed securities - home loans. While this move is helpful, we view it as a necessary, but by itself insufficient, step to returning the US economy to sustained growth. The main stumbling blocks to US growth are households needing to further reduce debt and the government needing to narrow its deficit, without derailing the economy.
But the NZD is set to stay high
With New Zealand's growth prospects relatively rosy, we expect the kiwi dollar to hold above the 80 cent mark in 2013. Our November forecasts show the New Zealand economy growing by 2.5 per cent and 3.2 per cent in 2012 and 2013, compared to 2.1 per cent and 1.7 per cent in the US.