A flying Kiwi is good for the Aussie dollar

The Reserve Bank of New Zealand's aggressive monetary policy stance is driving AUD/NZD weakness and creating an attractive interest rate differential.

While all the focus from the Reserve Bank is on a higher Aussie against the greenback, Governor Stevens should be happy with the lower value against its Trans-Tasman rival the Kiwi. In January this year the Aussie dollar fell to an intraday low of 1.0490 against the Kiwi and it threatens to trade even closer to parity in coming weeks.

The weakness in the AUD/NZD cross rate may come as a surprise to many who don’t follow it as closely as the more widely reported AUD/USD exchange rate but it has been building for some time now. The main driver, as is often the case for currency fluctuations, has been the aggressive monetary policy stance of the RBNZ. Since March this year the Reserve Bank of New Zealand has raised interest rates from 2.5 per cent to 3.25 per cent, and it is expected to continue along this path with rates to hit 4 per cent in the first quarter of 2015.

With the Reserve Bank holding fire on interest rates, possibly until the end of the year, the carry trade has become attractive for those looking to exploit the widening interest rate differential. By selling AUD, now the low yielding currency with a 2.5 per cent official cash rate and buying the NZD, the higher yielding currency with 3.25 per cent official cash rate, there is an interest rate benefit for the holder of the Kiwi.

Graph for A flying Kiwi is good for the Aussie dollar

The chart above shows a clear point of inflection where the downside in the AUD/NZD cross accelerates in June, dropping rather rapidly from 1.1000 to 1.0650. This was the point at which the RBA moved to a neutral stance, confirming interest rates would remain on hold giving investors more confidence in the trade.

This week sees the release of the New Zealand CPI report, with inflation for the second quarter of 2014 expected to have climbed from 0.3 per cent in the first quarter to 0.4 per cent, increasing the annual rate from 1.5 per cent to 1.8 per cent. This would put more upward pressure on interest rates and could be the catalyst for a move in the NZD/USD through post float highs at 0.8850 and AUD/NZD through 1.0500.

Jim Vrondas is Chief Currency strategist, Asia-Pacific at OzForex, a global provider of online international payment services and a key provider of Forex news. OzForex Group Limited, is a publicly listed entity with shares traded on the Australian Securities Exchange under the code OFX.