FX Outlook 2018 – NZD to outperform the euro

by: Georgette Boele

In this publication: The New Zealand dollar (NZD) was the weakest G10 currency in 2017.The NZD will probably outperform the euro in 2018 as the central bank will move slowly towards tightening policy. NZD will continue to underperform the US dollar though. 2019 should be a positive year for New Zealand dollar

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2017 was a weak year for New Zealand dollar

The New Zeeland dollar was completely out of favour in 2017. It has declined by 12% versus the euro and 1% versus the US dollar making it the worst-performing G10 currency in 2017. Why? First, yield spread has moved against the New Zealand dollar have weighed on the currency. Second, weakness in dairy prices has also been negative for the New Zealand dollar as this is one of its main export products.

Third, election uncertainty in New Zealand has also acted as a headwind. There is a complete change in the political landscape. Labour formed a coalition with Nationalist New Zealand First and signalled an abrupt change in policy compared to the past. The new government has communicated that it aims at supporting economic growth without a deterioration in government finances. It promised to cut migration, which has given considerable support to growth in the past. Moreover it said that it will ban foreigners from buying houses in New Zealand. In addition, it stated that it will review and reform the Central Bank Act. Labour said in its election campaign that it would like to add full employment to its existing sole mandate of price stability. These developments have concerned investors and this has weighed on the New Zealand dollar sentiment. Has the New Zealand dollar seen the bottom? We try to answer this question in this report.

Mixed in 2018 and upside in 2019

We expect some upside for New Zealand dollar versus the euro as the Reserve Bank of New Zealand (RBNZ) will slowly but surely move towards tightening monetary policy. This is because positive growth momentum and above-trend growth will probably result in some upward pressure in inflation. The RBNZ has a 1-3% range for inflation but would like to keep inflation close to 2%. We expect a 25bp rate hike while financial markets have priced in a probability of 50% of such a hike. The RBNZ has signalled barely one 25bp rate in the coming two years. We think that this is too bearish. Expectations for a rate hike should support the NZD versus the euro but not versus the US dollar as we also expect more Fed rate hikes than market consensus.

For 2019, we have pencilled in a total of two 25bp rate hikes which is more hawkish than market consensus and the projections by the RBNZ. This should provide strong support to the kiwi in 2019 even is market focus is also on ECB rate hikes. We expect the overall commodity index (CRB) to rise and investor sentiment to be constructive in 2018 and 2019. These developments will be supportive for New Zealand dollar. All in all, the New Zealand dollar will be mixed in 2018 but we expect it to appreciate in 2019 on de back of central bank tightening and a positive investor sentiment.

In the alternative scenario, if the housing market and the economy were to slow down considerably, then it is unlikely that the RBNZ will hike and therefore the New Zealand dollar will probably decline.