Exporters — dairy farmers in particular — were quietly seething this week. They had to watch as milk powder prices fell 5 per cent at the GlobalDairyTrade auction on Wednesday, extending the fall of New Zealand's most important commodity price to almost 30 per cent this year. Yet the New Zealand dollar didn't budge.
The currency has appreciated 7 per cent this year, despite a 30 per cent fall in dairy and log prices. This is not how it's supposed to work. Typically, the currency will fall and rise in line with commodity prices, which softens the blow for farmer incomes. A fall in the New Zealand dollar in line with our export commodity prices sends a strong signal to our consumers that they should dial back all the spending on imports.
Instead, dairy and log prices are falling as the New Zealand dollar is rising. That compounds the pain for farmers, loggers and the provincial economies they support.
This was clear in ANZ's decision to downgrade its forecast for the Fonterra milk payout in this 2014/15 season to $6.25/kg. The double whammy of lower dairy prices and a higher dollar is a triple whammy because of the 75 basis point increase in interest rates since March.
This rise is at the heart of the currency's divergence from commodity prices. The Reserve Bank is the only central bank in the developed world to increase interest rates. Interest rates in Europe and the US are flat to falling.
This widening interest rate differential has made our debt doubly attractive. The Reserve Bank is widely expected to put the Official Cash Rate up another 25 basis points on July 24, and another 100 basis points through next year.
Currency markets are usually good at absorbing these forecasts, which means the Reserve Bank has been surprised its rate increases seem to have pushed up the currency again.
Other forces are at play. The US economy has underperformed. The European economy has been mired in high unemployment and very low inflation, which has forced the European Central Bank to cut its deposit rate to a negative level and talk about printing money.
But there's also some pull in this flow of money into New Zealand that is putting up the currency. The Government is borrowing less, but foreign holdings of bonds has increased to $43 billion from $34b two years ago.
Also, councils have started borrowing overseas in earnest for the first time and big companies have been borrowing much more heavily in New Zealand dollars over the past two years.
The combination of all this borrowing has been an extra $12b in demand for New Zealand dollars in the past two years.
The Reserve Bank has commented regularly over that time that the New Zealand dollar is overvalued relative to New Zealand's commodity prices and its current account deficit.
Governor Wheeler even suggested in May to dairy farmers that the Reserve Bank could push the currency down, as it did quite profitably in 2007 and 2008.
But it can't do that if it conflicts with its main aim of keeping inflation under control, given that lower currency pushes up imported prices.
The frustration is palpable for exporters, who can see the high dollar is helping to achieve the Reserve Bank's aims and is wonderful news for consumers.