Higher Interest Rates May Weaken NZ Dollar, Says BNP Paribas

The New Zealand dollar is likely to become “weaker” as higher interest rates are exposing the vulnerabilities in the country’s household finances putting the country in a tough spot, new research from BNP Paribas, the global investment bank and lender, said.

BNP Paribas said that rising central bank interest rates will impact some economies more than others, with New Zealand and Sweden looking particularly exposed.

Parisha Saimbi, FX Strategist at BNP Paribas, said that Sweden and New Zealand appeared most vulnerable to a property-led economic downturn, according to their analysis and this will have implications for the NZ Dollar’s outlook.

The Reserve Bank of New Zealand (RBNZ) has announced eleven interest rate hikes since October 2021, taking the Official Cash Rate to 5.25%.

This is exerting pressure on local lenders to raise rates on their own loans and mortgages which puts the squeeze on businesses and households with the intention of bringing inflation in the economy under control.

However, there is a risk interest rates rise to levels that prompt a severe contraction in house prices and economic recession. Indeed, money market pricing shows investors see the prospect of at least one further interest rate hike from the RBNZ in 2023, which will heap further pressure on those households needing to re-mortgage.

House Prices Readjusting

Saimbi further said that with interest rates climbing towards pre-GFC levels, house prices in several countries were readjusting lower to factor in the higher cost of capital, risking some recent home purchasers slipping into negative equity.

BNP Paribas said the marginal buyer of real estate is often highly leveraged and therefore susceptible to changes in the value of their asset or the cost of their mortgage.

The bank’s new research explores the vulnerability of the marginal buyer in each G10 region according to several factors, laid out, according to data from BNP Paribas (see chart).

The BNP Paribas research found that New Zealand’s household sector was particularly exposed because of the following reasons:

Low excess savings having accumulated over the Pandemic.

A sharp increase in debt service ratios, with the rise in interest rates, to levels well above pre-pandemic average levels.

Elevated levels of overall household leverage, due to a significant increase in household debt over the past three years far outpacing growth in the real economy

A substantial proportion of new borrowing over the past year being variable-rate, suggesting a larger pool of new borrowers exposed to the sharp increase in interest rates.

“We see risks that the RBNZ may not be able to deliver as many hikes as it projects or may need to cut rates earlier and/or more aggressively,” Saimbi said.

Indeed, while markets also see one more rate hike from the RBNZ they are also factoring the OCR to be below current levels by year-end.

For the currency, the pace of future rate cuts is now arguably more important than the potential rate hikes yet to come. “In turn, we also favour trading NZD from the short side this year and are already short NZD versus Japan’s Yen and Australian dollar in our model portfolio,” Saimbi add

New Zealand Hikes Interest Rate

It was on April 4 this year the New Zealand Reserve Bank has raised rates by 50 basis points, bringing the benchmark interest rate to 5.25% and higher than economists’ expectations of a 25 basis points hike.

The latest move brings the interest rate to the highest level since October 2008. This follows the previous hike of 50 basis points, which saw the interest rate move from 4.25% to 4.75% in February.

The New Zealand dollar strengthened 0.59% to trade at 0.6351 against the U.S. dollar.

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