×

The new currency trade: Short the Kiwi

Mark Coote | Bloomberg | Getty Images

Currency analysts are betting on continued declines for the New Zealand dollar as officials fight to boost growth in a country that was heralded 2014's rockstar economy.

The Kiwi sank over 2 percent to a near five-year low of 70 U.S. cents Thursday after the Reserve Bank of New Zealand (RBNZ) lowered the benchmark cash rate by 25 basis points for the first time in four years.

"Today's announcement is significant for NZD because it marks the beginning of what could turn into a more prolonged easing cycle. Desynchronization of monetary policy should not only drive NZD/USD below 70 cents but take it lower against many other major currencies," said Kathy Lien, managing director of FX strategy at BK Asset Management.

Indeed, chances for parity with the Australian dollar, a popular call this year, are now over, noted Evan Lucas, market strategist at IG.

RBNZ Governor Graeme Wheeler also left the door open to future cuts should economic data weaken further, adding that the currency remains overvalued despite a 17 percent fall against the greenback over the past year. The move surprised many economists who expected the bank to hold fire following consecutive hikes throughout 2014; the RBNZ was the first central bank in the developed world to increase rates after the global financial crisis.

How low will the Kiwi go?

It's likely to hit 68 U.S. cents over the next one to two months, warned Jonathan Cavenagh, senior FX strategist for Asia at Westpac Institutional Bank.

"Given the RBNZ signaled it wasn't done with one cut, the market will get quite aggressive with its rate outlook, leaving the Kiwi vulnerable to more downside."

Read MoreCould a kiwi with laser eyes be on this nation's next flag?

National Australia Bank economists are forecasting another 25-point cut next month, followed by another one in September.

Another catalyst that could drive the Kiwi lower is the interest rate differential with the U.S, Cavenagh said. The Federal Reserve is now widely expected to delay raising rates until 2016 due to sluggish wage and inflation data.

So, why cut rates now?

Low inflation and overall demand are weighing on New Zealand policymakers, as is the plunge in milk prices. The Global Dairy Trade (GDT) price index at Fonterra, the world's leading exporter of dairy products, is currently at a six-year low. Dairy accounts for 20 percent of the New Zealand's total export income

Meanwhile, annual consumer price inflation rose just 0.1 percent in the first quarter, a 15-year trough. Despite forecasting inflation to return to the RBNZ's target range of 1-3 percent in 2016, gross domestic product (GDP) forecast for next year was still cut to 3.3 percent from 3.8 percent previously, Lien pointed out.

"The problem is clearly growth and if that does not pick up, the central bank may have to cut again," she said.

A weaker currency should lift dairy prices and improve the country's terms of trade, but it comes at a high cost. New Zealand home prices have witnessed a meteoric rise in recent months, especially in Auckland, triggering fears of a property bubble.

"Governor Wheeler is clearly concerned about Auckland's housing market but the state of the whole economy forced his hand. It looks and sounds very similar to the bind Governor Stevens finds himself in with Sydney and the rest of the Australian economy," said IG's Lucas.