KEY POINTS:
Like a visitor who's outstayed his welcome, the New Zealand dollar refused to budge from high levels this year, despite forecasts.
It rose to US81.6c against the United States dollar, its highest level since the currency was floated in 1985, and the Reserve Bank intervened in the market
for the first time because it viewed the exchange rate as unjustifiably high.
The soaring kiwi rose 5.3 per cent against the currencies of our major trading partners, and 12 per cent against the greenback, barely dipping below US70c all year.
And it showed no sign of weakening .
"It will be remembered as another year when the New Zealand economy was resilient, despite the efforts of the Reserve Bank to slow the economy through tight monetary policy," John Body, head of markets at ANZ Institutional Bank, said.
"As a result we've got the 90-day bill rate ending the year close to 9 per cent and the kiwi ending the year close to US80c."
Forecasters who thought it would head back to US60c this year agreed it was the year of forecasting badly.
"We used to think the kiwi was usually US50c-US70c," Body said. But now, "US70c-US85c is a more realistic range for it".
The drivers behind the dollar have been consumer demand and high commodity prices, particularly for New Zealand dairy products.
But where consumer demand is seen as a fickle thing, the terms of trade are hard to refute. Thus the strong kiwi has gone from being "unjustifiably high" - in the words of the Reserve Bank - to somewhere near normal.
In June, the Reserve Bank lost patience, deciding to intervene in the currency market - the first time since the currency was floated 22 years ago.
It sold $700 million in June and backed that up in July with a hefty $1.5 billion of sales.
There was temporary respite for exporters and initially it looked as though the bank had succeeded.
The kiwi was knocked down 18 per cent from a post-float high of US81.10c on July 24 to a trough of US66.37c on August 17, but the fall was not sustained.
The Reserve Bank's main adversary was the "carry trade", where risk-hungry investors borrow in low-interest-rate countries such as Japan and Switzerland and buy high-interest-rate currencies such as the kiwi and the aussie.
Aided by easy money, the markets were losing sight of fundamentals until the international credit crunch hit, Westpac currency analyst Michael Gordon said.
"It's been a real year of two halves," Gordon said. "The first half of the year was dominated by talk of carry trades, I guess almost to the exclusion of other things, where interest rates explained a lot of what was going on in currencies.
"And it's been really the second half of the year, from late July onwards, where it's been the credit market concerns that have dominated what's going on."
Credit concerns, precipitated by the US subprime mortgage crisis, introduced greater volatility but their impact on the kiwi was intermittent and so far temporary.
The effect of soaring dairy prices was significant. Some analysts believed dairy prices have undergone an upward "paradigm shift", justifying a permanent rise in the kiwi.
Dairy prices are double what they were a year ago, and although they seem likely to come off their current highs next year, the outlook remains bright, due to the rise of biofuels and ongoing demand from emerging economies.
"A strong outlook for soft commodities will provide a solid foundation of growth in New Zealand despite the current troubles in financial markets around the world," Australia's Macquarie Bank said.
Macquarie said the extra stimulation could lead to "agflation" - inflationary pressures which could prompt interest rate hikes again next year and which, in turn, could make the kiwi even more attractive.
Next year is an election year, and tax cuts are at the forefront, which could also stoke inflation.
This has prompted economists to shift their prevailing view that New Zealand is headed for a slowdown.
"I think in particular there will be a lot of people offshore who will still be surprised at just how significant the dairy story is and may find that whatever they think of the New Zealand economy now, that they've perhaps got it wrong and need to be holding New Zealand dollars after all," Gordon said.
Of course, the new year might also bring the much-feared US economic slowdown or a Chinese meltdown. But Gordon thought New Zealand could be less affected than one might think.
The New Zealand economy is much more closely tied toAsia which is booming, he explains, and helps to insulate New Zealand from the US situation.
All this points to at least one more good year for the New Zealand dollar.
ANZ is forecasting a range of US70c-US85c for the kiwi in 2008, weakening as the tight monetary conditions bite. It predicts the kiwi-aussie cross will range from A83c to A90c.
This is not good news for exporters who are unhappy, not just because the high dollar eroded margins, but because of the kiwi's unpredictability.
Fisher & Paykel Healthcare, Rakon, Pumpkin Patch and other major exporters all felt the effects of foreign exchange losses and lamented the difficulty in hedging.
One last observation Gordon made about 2007 was the sea change in how currency markets and the Reserve Bank related to each other.
- NZPA
