Richard Prebble: US interest rate hike has slammed NZ dollar

More pain ahead: Federal Reserve Chairman Jerome Powell speaks during a news conference at the Federal Reserve Board building in Washington. Photo / AP

Opinion

OPINION:

First, the good news: the ANZ Truckometer uses traffic volume data to give an accurate measure of the economy. The latest report says: "The Light Traffic Index bounced 5.4 per cent in August, while the Heavy Traffic Index jumped 7 per cent".

The economy is booming.

The heavy traffic index indicates what is happening now. The light traffic index indicates what is likely to happen over the next six months — a strong summer.

Now the bad news: the world economy took a hit last week and so did New Zealand.
The US Federal Reserve lifted its interest rate to 3.25 per cent.

The impact on New Zealand was immediate. The kiwi fell to US58 cents. International trade is largely conducted in US dollars. The cost of almost everything we buy from overseas, from petrol to foreign travel, now costs more.

Our Reserve Bank's interest rate at 3 per cent is lower than America's. With lower interest rates, money will flow out of New Zealand to the US.

There are advantages of a cheaper kiwi. Exporters, such as farmers, earn more and it's a boost to tourism.

But despite the repeated claims of commentators, New Zealand is not an exporting country. We are an importing country. In August the trade deficit was $2.4 billion. New Zealanders spend more overseas as tourists than international tourists spend in this country. New Zealand has a chronic deficit that has to be funded in US dollars.

Traders who just 12 months ago were willing to pay US74c for the kiwi are now paying 20 per cent less.

There is no bottom for our floating currency. In the past the kiwi has fallen as low as US39c. As long as New Zealand's interest rates are lower than interest rates in the US, the kiwi will keep sinking.

It's what economists call "sovereign risk". It is the reason Waikato dairy farmers, the world's most efficient, pay more for a bank loan than the American dairy farmer who needs a quota to sell his highly priced milk. New Zealand is a riskier country than America. Investors demand a higher return.

New Zealand's sovereign risk has historically been around 2 per cent. Everyone — government, business, consumers — must pay that extra 2 per cent on borrowings. The size of our sovereign risk is being reassessed every minute by currency traders.

The Federal Reserve has vowed to go on increasing interest rates until inflation is at 2 per cent. Current predictions are that the Fed will raise its interest rate to 4.5 per cent but that rate could go higher. The Fed chairman appears to acknowledge that these interest rate rises will cause a US recession.

The saying is: "when the US sneezes, the world catches a cold". Being an open, small economy, New Zealand catches the flu.

The international outlook is grim.

China is continuing with economically punishing Covid lockdowns. More serious is the collapse of the Chinese property bubble. Chinese property developers owe an estimated US$5 trillion.

High energy prices caused by the Ukraine war will result in an economic retraction in Europe.

The Labour Government has burned through 30 years of fiscal prudence. It is running deficits when the economy is growing. The Reserve Bank's balance sheet is weighed down by $60 billion of debt from its money printing.

For two years the world believed our propaganda that the "New Zealand model" of Covid lockdowns was a success. The failure of the policy in China has caused currency traders to reassess the New Zealand economy. They do not like what they see.

Britain and Turkey are examples of what not to do. The pound is in free-fall. The Bank of England last week set British interest rates lower than those in the US. Meanwhile, the new British Finance Minister announced a deficit spending programme that makes Grant Robertson look prudent.

The Turkish president believes interest rates cause inflation. He has ordered the Turkish central bank to lower interest rates. The Turkish lira that once was on par with the kiwi is now at 18.4 to the US dollar. Inflation is at 80 per cent.

The only way to restore the kiwi is to run a prudent fiscal and monetary policy. The Reserve Bank tightening monetary policy while the Government borrows and spends is madness. Both fiscal and monetary policy need to target inflation. The Government must balance the budget.

With inflation at 7.3 per cent, an official cash rate (OCR) of just 3 per cent will not return inflation to 2 per cent. We need an OCR higher than US Federal Reserve's rate and action to shrink the Reserve Bank's balance sheet.

When the world sees our fiscal and monetary policies are prudent, then confidence in the kiwi will be restored.

Today we are on the road to Turkey, persistent inflation and our currency losing value.

- Richard Prebble is a former leader of the Act Party and a former member of the Labour Party.