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Currency Forecast: NZD/USD Outlook

After achieving nearly 5% GDP growth in the previous year, New Zealand is headed for a slight slowdown in 2005. Although first quarter GDP is expected to show a 0.8% expansion over the quarter, with the central bank expecting 1%, it is a rather small figure compared to the 2.1% achieved in the same quarter of last year. The effects of the Reserve Bank of New Zealand 's interest rate increases, totaling 1.75 percentage points since early 2004, are now being seen in the economy. The unemployment rate grew to 3.9% in the March quarter after falling to 3.6% in the December 2004 quarter. On the other hand, due to shortages in certain occupations, salaries and wages continued to grow 2.5% on a year to year basis in the first quarter of 2005.

Interest Rate Hikes Being Felt
Firms are already feeling the pinch from the higher interest rates as business confidence hit a new low of -56.7% in May after reaching -48.0% in April. Meanwhile, the higher borrowing costs haven't had the same sharp effect in the housing market. Although a dip was seen in April, total sales value was back up to NZ$3,023.7M in May. This, along with the aforementioned wage increases, are part of the reason that inflation is still high, despite the central bank's efforts to contain it. The latest CPI release put the annual price increase at 2.8%, just below the RBNZ inflation target's upper limit, for the year ending in March 2005. Most of the inflation pressure is still domestic as the tradable price component decreased 0.5% in the quarter due to the NZD consistently rising to new highs near 0.7450 in March. As for the elevated current account balance, there will be a large bit of relief granted in the first quarter from an improved trade balance from a seasonal effect. However, the much larger investment income balance will remain NZ$2,413M in the red due to the repatriation of high profits earned by foreign-owned firms.

RBNZ on "Wait And See Mode"
The March rate hike, bringing the target rate to 6.75%, may have been RBNZ Governor Alan Bollard's last. The monetary authorities are basically playing a waiting game now to see when the latest string of hikes will fully manifest itself as lowered demand. Lately, it seems that the economy has mostly been limited by capacity constraints. At the same time, while corporations will definitely factor the higher rates into their investment decisions, the effects might be less defined in the consumer market. About 75% of the loans presently taken out by New Zealanders are at fixed rates, which are more influenced by global bond yields that pull the costs down significantly lower than current floating rates. Since the latter half of 2003, the effective average mortgage rate has only risen 65 basis points. What this means is that the central bank will have to wait several more months for their rate hikes to hit housing prices, and in turn, consumer prices. Some risks pointing to another potential increase include a planned expansion in government spending, which will contribute to total domestic demand. Of course, it may be more important for the RBNZ to protect the economy from a hard landing by practicing patience for the remainder of the year.

Risks Exist on Both Side For Economy
The economy will continue to calm down during the rest of 2005. As demand eases and new business investment effects filter through, productivity will improve thereby relieving capacity utilization and pushing it down from recent highs. This implies that employment growth will slow down as firms require less workers to produce the required amount of goods. Taking the worrisome business confidence figures into account, it seems as if the economy could be headed downwards faster than is expected or desired. However, the comforting fiscal surplus ensures a nice spending package to support output if necessary. Also, currency adjustments are expected to balance out some of the changes in the economy. After having peaked twice in the first half of 2005, the NZD has few basic pressures working upon it. The closing interest rate differential will most certainly reduce demand for the currency as it loses carry trade advantage against the US dollar; the Fed is looking to increase rates while the RBNZ is sitting on the peak of its rate. Commodity and food prices, of course, are working in the other direction and could push the kiwi up. Although the NZD index for commodity prices was falling for a good portion of 2004, the decline was halted in January and prices are slowly rising once again.

Technical Outlook
The New Zealand dollar has remained relatively unchanged over the past six months as the pair continues to consolidate within a large triangle, while remaining far above the major trendline that has dominated the price action since middle of 2002. The next six months will most likely see the New Zealand dollar break below the triangle and aim for the major trendline below 0.70. A failure by Kiwi longs to hold up the currency will most likely result in the pair beginning to reverse its course and start a new greenback dominated trend. For the time being, indicators still point to range trading conditions with Stochastic treading along the oversold line. ATR is pointing to a rise in volatility, which remains historically high, with the pair maintaining 160-pip range on average over the past year. High volatility is usually indicative of trend reversals, which might be the case with the New Zealand dollar. ADX (DMI) is adding to a range trading setup with DI+ and DI- continually crossing each other, thus constantly issuing buy and sell signals.

Key Levels: The New Zealand dollar has remained relatively unchanged over the past six months as the pair continues to consolidate within a large triangle, while remaining far above the major trendline that has dominated the price action since middle of 2002. The next six months will most likely see the New Zealand dollar break below the triangle and aim for the major trendline below 0.70. Enlarge Chart View
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