Given New Zealand’s persistently lower rate of inflation, i was not surprised to see that the NZD REER (broad real effective exchange rate) has appreciated by less than the AUD, however i was surprised at the gap between the two markets.
Relative to the average REER between 2002 and 2008 (inclusive, i chose these dates as they span a full cycle) the AUD is 29% higher, whereas the NZD is only 11% higher.
This leads to interesting questions about why the RBNZ is selling FX. Part of the answer is that unemployment is high and inflation is low — and the other part is that the RBNZ are uncomfortable with the pace of house price appreciation. Thus, as they fear the financial stability implications of easing financial conditions via lowering their target overnight cash rate, they are attempting to ease them by lowering the value of the NZD.
I think that this is purely about the lack of other good options. With only an 11% increase in the REER over the prior cycle average, New Zealand isn’t even on the leader-board for real FX pain. If they get the housing market under control using macro-prudential controls, they seem a soft touch to revert to traditional tool, and to cut rates below 2.5%
The top seven markets for REER appreciation (as measured by the percentage increase over the 2002-2008 average REER) are in the chart above.
The largest REER appreciation, by far, has occurred in Brazil. Here, the authorities intervened to cap the BRL and (in a victory for economics) pushed the inevitable real adjustment onto domestic prices via higher inflation. So while the nominal increase in the BRL has been reduced, the REER is higher, and is now ~40% above the prior cycle average. It is a similar story for Russia (+35%).
Australia is the fifth most impacted, with the REER ~29% above the cycle average; this is close to the ~27% REER appreciation in China.
Given that Australia is well ahead of NZ on the FX-pain leader board, should the RBA intervene?
I do not think that it would achieve all that much – the RBA might get a little more domestic inflation, but (like Brazil) it is unlikely to change the real FX story very much.
So why is it okay for NZ? Their inflation target is 2% and they are stuck at 1% just now, so a bit more inflation would be welcome. It is not yet clear that the RBA has a problem with inflation being too low. We have had some low prints, but it is not yet a problem.