You may have noticed that the New Zealand dollar has been particularly strong lately – currently sitting just below its all time highs at around US$0.82. The NZD has averaged at US$0.60 ever since floating in March 1985; therefore it is approximately 36% above that historic average.
The two reasons for this strength are well understood, and are problems being faced by many countries, including NZ, around the world.
1 – The terrible US budget deficit.
2 – High levels of debt and a property market that many believe has not yet reached the bottom.
In comparison, NZ is in a comparatively better state. Our economy is based on agricultural produce that have strong demand, and our neighbouring Australia is blessed with a rich mining sector. Additionally, our Reserve Bank is seen as credible, our Government sensible, and our outlook better than most in the eyes of many global investors. New Zealand’s interest rates are also attractive, with our OCR of 2.5% being relatively more appealing than the equivalent 0.25% in the US and 0.5% in the UK.
Neighbouring Australia is one of the few countries with a higher cash rate, at 4.75%, and that is one reason why our dollar is currently only buying around A$0.76 Australian dollars, below the long-term average of around A$0.83. So in a historic context, NZ appears overvalued against most currencies across the globe, but undervalued when compared to Australia.
It is important to note that it is not a bad thing to have a strong currency – it can be likened to a vote of confidence. For those New Zealanders travelling overseas, our spending power is much improved with a high currency.
On the negative side; our export sector suffers when it comes to high currency, although not all exporters are impacted as badly. Fonterra’s recently upgraded forecast payout range highlights how strong the demand for dairy produce is, despite the record high currency.
The high currency is more problematic for the manufacturing and tourism sectors in NZ. These industries haven’t had the same corresponding increase in the value of the products they sell.
While the majority of forecasters see the potential for momentum to carry the currency higher in the short-term, the general consesus among the major banks is that the NZ dollar will fall to around US$0.74 by the end of 2011, and then continue to fall to US$0.72 by the end of the 2012. Therefore an estimated fall of approximately 13%, which would still see the dollar trading well above its historic average.
Against the UK Pound the average forecast suggests a decline of a similar magnitude from £0.50 to £0.43 by the end of next year.
Forecasters expect the NZ currency to trend back toward its long-term average of A$0.83 against the Australian dollar over the next three years, a rise of about 8%.
Currency estimates change often, and are often inaccurate too. But taking a step back from the short-term noise of financial markets, there is a case for taking advantage of the high NZ dollar and adding some global shares to investment portfolios.
Given the unusually weak exchange rate against the Australian dollar, it could also make some sense to sell a few Australian shares to fund these purchases. To reduce some of the timing risk, we would suggest buying in instalments. By doing this, if the currency increases further, which it could well do while it has such momentum, some of these purchases would take advantage of the even higher exchange rate.
