Inside Economics: Why the Kiwi is so strong against the Aussie dollar, the big Budget squeeze ... and asset recycling

The Kiwi dollar has been surprisingly strong against the Australian currency. Photo / Milleflore Images

Welcome to Inside Economics. Every week, I take a deeper dive into some of the more left-field economic news you may have missed. To sign up for my weekly newsletter, click here. If you have a burning question about the quirks or intricacies of economics send it to liam.dann@nzherald.co.nz or leave a message in the comments section.

Aussie rivalry

Q: Hi Liam

I very much enjoy your informative Inside Economics articles. I am from Auckland but have lived in Brisbane for 20 years and hold an MBA in international business, Asian studies. I travel to and from Auckland regularly, including just last week, have investments in both countries and regularly move funds in both directions.

My question is: based on fundamental micro and macro-economic comparisons of the current New Zealand and Australian economies, what factors, in your opinion are keeping the Kiwi dollar in the 90c+ range to the Australian dollar?

The reason I ask is that the two places I spend time, Auckland and Brisbane, the strength of the NZ dollar is not warranted because the lived experience in each city currently is very different. And respective reserve bank rates and forecasts are diverging.

Warm regards,

John G.

A: Thanks John. You’re right, the Kiwi does seem surprisingly strong against the Aussie dollar, given the state of the two economies and much lower interest rates over here. At the time of writing, the Kiwi was buying 93 Australian cents.

It had me baffled, so I asked BNZ senior markets strategist Jason Wong, who watches it all much more closely than I do.

Wong says he’s also been a bit bemused by the Kiwi’s strength.

But the real mystery was why it didn’t fall away a lot more last year when we were clearly in recession, and the Reserve Bank (RBNZ) was cutting rates hard, he said.

Meanwhile, Australia’s economic growth was holding up well, it had higher inflation and a central bank that was reluctant to cut rates.

Right now, the simplest explanation for the strength in the Kiwi dollar relative to the Aussie dollar was that Australia looked to be more exposed to the fallout of a trade war between the US and China, Wong said.

So the market view is that hard commodities like iron ore and copper are going to come under more pressure from the trade squeeze than soft commodities, such as dairy.

Dairy prices have remained strong. They are one of the key indicators that international traders consider when weighing up the New Zealand economy.

With Australia having a closer political relationship to the US and generally a more terse relationship with China, it may also find itself closer to the sharp edge of the geopolitical tension.

New Zealand’s domestic economic recovery does appear to have faltered in the past few weeks, and after all the tariff turmoil, the RBNZ is expected to cut rates further.

But the same kind of story – of trade wars slowing the global economy – is playing out in Australia, so that has not affected the balance of things too much.

Perhaps, although this is just me speculating now, the Federal election is weighing on the Aussie dollar too.

It’s been notable that both the major parties – Labor and the Liberal/National coalition – have been under fire for fiscally irresponsible spending promises.

Meanwhile, as was reiterated by Finance Minister Nicola Willis in her pre-Budget speech yesterday, the New Zealand Government remains committed to playing it tight.

Rise against the greenback

More broadly, the Kiwi has risen sharply in value against the US currency in recent weeks.

It has been trading up around US60c – up from around US55c just a few weeks ago.

NZ Herald senior markets reporter Jamie Gray took a look at the big picture last week.

“The imposition of trade tariffs and [US President Donald] Trump’s attacks on [Federal Reserve chairman Jerome] Powell have tarnished the US dollar’s allure as a safe-haven currency, which has boosted the Kiwi dollar and several other currencies,” Gray wrote.

The market was taking a view that its trade policy was going to upset the US economy and that recession risk had become heightened, BNZ’s Wong said.

“The other dynamic is structural, where Trump is chipping away at the bedrock that the US economy has been built on – free trade, free capital flows and an independent Federal Reserve,” he said.

“All these sorts of things are under threat, so the risk premia around US assets has increased and the weaker US dollar is a byproduct of all that.

“Over the last decade, the US dollar and the US economy have outperformed and everyone has been long [on] US dollars, wanting a piece of the action, so that trade is just beginning to unwind.”

US President Donald Trump (left) looks on as his nominee to chair the Federal Reserve, Jerome Powell, takes to the podium during a press event in 2017. Photo / Getty Images

Bond battle

On a similar theme at the weekend, Wellington business editor Jenée Tibshraeny has taken a look at how US indebtedness (and dependence on the bond market) is curbing Donald Trump’s policy ambitions.

With US net debt nearing 100% of gross domestic product (GDP – New Zealand’s is at 25%, according to the same measure of debt used in an IMF comparison), its interest costs are material, she writes.

Trump needs interest rates to fall to stimulate growth and ease the cost of servicing the US’ big pile of government debt.

Yet the more brazen he gets with tariff policies and threats to erode the independence of the Federal Reserve, the riskier he makes investing in US Government debt, otherwise known as bonds or treasuries.

If investors believe they’re taking on more risk, they’ll demand higher returns.

Tibshraeny quotes Harbour Asset Management co-chief executive Andrew Bascand, who describes the bond market as the US’ “Achilles heel”.

All bets are off

Unpredictable moves on currency markets, extreme volatility on equity markets ... there’s no question we’re in unprecedented territory, with US policy overshadowing everything in the global economy.

BNZ head of research Stephen Toplis attempts to put a bit of context around the chaos with a research note this week titled “Central Banks in Disarray”.

He points out that it is nearly impossible for central banks to produce credible long-term forecasts right now – and some have given up.

The Bank of Canada has stopped publishing forecasts and the European Central Bank did not provide forward guidance on its rate track when it released its latest monetary policy decision.

The RBNZ doesn’t have to publish new forecasts and update its rate track until the next Monetary Policy Statement on May 28, but it’s hard to know if the outlook will be much clearer then.

Toplis makes the case for pausing long-term forecasts and concentrating on more in-depth analysis of a range of different scenarios.

The RBNZ does have a track record of withdrawing guidance, he says.

In the monetary policy decisions of May 2020, August 2020, November 2020 and February 2021 (as Covid raged), it provided no Official Cash Rate (OCR) projection past March 2021.

“There is no reason why it couldn’t do something similar at the May 28 announcement. It certainly couldn’t be blamed for doing so,” Toplis writes.

RBNZ officials had already highlighted the possibility that they might produce more scenario analysis in future, he says.

Budget squeeze

As mentioned earlier, Nicola Willis’ pre-Budget speech yesterday has made it clear that the Government is sticking to its guns on the fiscal plan.

Finance Minister Nicola Willis. Photo / Mark Mitchell

Despite forecasts of lower economic growth, which will translate to less tax revenue, Willis has reiterated the Government’s intention to have the Crown accounts back in surplus by 2029.

That means a big cut to spending plans with a proposed operating allowance just $1.3 billion, down from $2.4b.

That, according to Treasury, won’t be enough to fund the increased cost of delivering existing services, so expect to see more significant cuts to spending.

Willis argues there is scope there as the Government continues to reassess its priorities.

“The reality of global economic events is that if we’d pushed on with a larger operating allowance, then we would be staring down the barrel of even bigger deficits and debt,” Willis said.

Expect to hear plenty of debate in the coming weeks about the spending constraints, which some will argue are self-imposed.

The question ultimately comes down to how people feel about Crown debt and how quickly we need to pay it back to a more sustainable level – or exactly what a sustainable level is, for that matter.

It’s a tough balancing act for any Government, given the options are limited – tax more, cut spending or borrow more. Or, sell some assets ...

Asset recycling

New Zealand Initiative chair Roger Partridge made the case for another look at state asset sales in a column last week.

The Crown’s accounts record $44.3b of taxpayer equity tied up in state-owned enterprises, he writes.

“Yet these businesses struggle to deliver returns that justify continued Government ownership.”

It’s always a controversial topic in New Zealand, in part, I assume, because asset sales were done quite badly in the 1980s.

Of course, the extent to which people want the Government to be involved in owning and running assets is also one of the fundamental economic divides.

But ironically, one of the reasons the public is so suspicious of asset sales is down to a lack of trust in the Government to spend money wisely.

It doesn’t matter how good the logic for selling an asset is; if the Crown squanders the windfall, we’re no better off.

With that in mind, Partridge highlights the success New South Wales has had with a disciplined approach that ensures money from asset sales is “recycled” into new infrastructure projects.

“NSW has generated A$53 billion ($56.9b) since 2012 through a straightforward principle: sell assets the Government does not need to own and invest the proceeds in infrastructure the public does need,” Partridge writes.

“Strong governance is the key to the success of the programme,” he says.

“Proceeds from the sale of state-owned assets were ring-fenced in the Restart NSW Fund, ensuring transparency and preventing funds from disappearing into general government spending.”

“This ring-fencing proved crucial for maintaining public support in a state where voters were initially as sceptical of asset sales as New Zealanders.”

Partridge points out that Prime Minister Christopher Luxon has already expressed some enthusiasm for the idea of asset recycling and suggests we may see National campaign on it for next year’s election.

Liam Dann is business editor-at-large for the New Zealand Herald. He is a senior writer and columnist, and also presents and produces videos and podcasts. He joined the Herald in 2003. To sign up to my weekly newsletter, click on your user profile at nzherald.co.nz and select “My newsletters”. For a step-by-step guide, click here. If you have a burning question about the quirks or intricacies of economics send it to liam.dann@nzherald.co.nz or leave a message in the comments section.