Wednesday 14th May 2014
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New Zealand's rising interest rates are likely to see a resurgence of the carry trade, driven by so-called retail investors who can borrow cheaply in their home currency, such as the yen, to invest in higher yielding currencies such as the kiwi dollar, the Reserve Bank says
Reserve Bank deputy governor Grant Spencer told Parliament's finance and expenditure select committee that while rising interest rates are largely priced into the kiwi dollar, the currency is still likely to attract retail investors in countries such as Japan.
"A lot of people in the market would say the increase in interest rates, given how well we've signalled what's coming, a lot of that's already built into the exchange rate," Spencer said. "The part that may be not built into the exchange rate is the response from retail investors, like the Japanese households who would be responding more to just the rate they see on the page, comparing different countries."
The carry trade has been muted in recent years, with limited issuance of Kauri, Eurokiwi and uridashi bonds, variants of New Zealand dollar-denominated bonds typically sold in offshore markets. Part of that has been due to the high cost of swapping foreign currency funding into New Zealand dollars, given the strength of the kiwi.
Annual Kauri bond issuance more than doubled to $4.8 billion in 2013, reducing what's been an elevated hedging cost since the global financial crisis, and could rise further because investors are "incentivised by the outlook for interest rates to rise to levels that are significantly higher than most other advanced economies," the Reserve Bank said in its six-monthly financial stability report today.
New Zealand 10-year government bonds are yielding about 4.3 percent while Japan's 10-year benchmark is yielding about 0.6 percent.
Reserve Bank governor Graeme Wheeler last week raised the prospect of intervening in currency markets to take the wind out of an elevated kiwi dollar as commodity prices come off. Persistent strength in the New Zealand dollar will likely keep a lid on future interest rate hikes, as it cools tradable inflation, which has been negative on an annual basis since June 2012.
Wheeler embarked on tighter monetary policy in March, and has hiked the official cash rate twice to 3 percent. The Reserve Bank projects the 90-day bank bill rate, seen as a proxy for the OCR, rising to 4 percent by the end of 2014 and 5.3 percent by March 2017.
The kiwi dollar has gained 2.4 percent to 88.29 yen this year, hitting a six-and-a-half year high in April 1. It has climbed 5.3 percent against the greenback this year, recently trading at 86.41 US cents.
Wheeler today told politicians he would expect the slump in dairy prices this year to start showing up in future terms of trade figures, which have been at a 40-year high largely on Asian demand for whole milk powder and infant formula.
"When we look at current other commodity exports, other than logs, which look to have come off just recently it looks as if the other commodity exports are still retaining their current price levels," Wheeler said.
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