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All eyes on S&P after Fitch cuts NZ credit rating to AA

Friday 30th September 2011

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Fitch Ratings’ decision to cut New Zealand's credit rating is stoking speculation of a similar move by Standard & Poor’s, which has the sovereign rating on negative outlook on the risks associated with the size of the nation’s external debt.

Fitch said foreign debt was a “key vulnerability" as it lowered the rating one notch to AA. It raised the outlook to ‘stable’ from ‘negative,’ where it had been since July 2009. New Zealand’s foreign currency rating at S&P is AA+.

Moody’s Investors Service has recently reaffirmed New Zealand's Aaa rating.

“The real news in today’s announcement is that it increases the chance that S&P also downgrade their rating to AA,” said Christian Hawkesby, head of fixed income at Harbour Asset Management in Wellington.

“By focusing on net external debt, S&P follows a similar methodology to Fitch.”

The New Zealand dollar recently traded at 76.88 U.S. cents, down from 77.66 cents before the Fitch statement. It earlier sank to a six-month low of 76.46 cents. Government bonds fell, pushing the yield on the 10-year benchmark bond up about 12 basis points to 4.46%.

Hawkesby said he doesn’t expect much more of a sell-off in New Zealand government debt.

“This still leaves New Zealand in the major league, more closely linked to core countries like the U.S., U.K. and Germany than European periphery countries or emerging markets,” he said. “While these are volatile times, we expect global investors to be able to put this news in context and continue to support the NZ government bond market.”

S&P credit analyst Kyran Curry wasn’t immediately available for comment.

Fitch’s statement said the nation’s high level of external debt “is an outlier among rated peers – a key vulnerability that is likely to persist as the current account deficit is projected to widen again.”

Fitch’s move “is a clear reminder of the ongoing vulnerabilities the NZ economy faces,” said Philip Borkin, economist at Goldman Sachs & Partners New Zealand. Borkin is forecasting the current account deficit will widen to 5.5% of GDP, from the 3.7% rate in the second quarter.

Fitch also cited high household indebtedness and eroding public finance as contributing factors. While New Zealand household debt was on par with other AAA rated countries like the U.S., U.K. and Australia, little progress had been made in clawing this back.

Westpac chief economist Dominick Stephens said the rating downgrade will theoretically lift the cost of funds in the New Zealand economy and for the government.

“Typically you would expect to see higher government bond rates, further widening of corporate funding spreads, a lower NZ dollar and lower short-term swap rates potentially combined with higher long-term swap rates, leading to a steeper yield curve,” Stephens said in a note today.

Even excluding the downgrade, the prospect of higher borrowing costs as a result of heightened financial market volatility “reinforces our view that the Reserve Bank remains firmly in wait and see mode for now,” he said.

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