Foreign Exchange

Flying Kiwi dollar to come ‘down to earth’: Goldman Sachs

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The flying New Zealand dollar is set to "come down to earth", says Goldman Sachs, forecasting a near 12 percent decline against the U.S. dollar over the next 12 months as previously supportive domestic drivers start to fade.

The currency has emerged as a market darling in recent months, rising 5 percent since the start of the year amid strong domestic economic momentum, a 40-year high in terms of trade and a relatively hawkish central bank.

It's tied with the Australian dollar as the best performing G-10 currency this year. The bank expects the kiwi – as the currency is informally called – to decline to $0.76 – or 11.6 percent lower from current levels.

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The currency last traded at $0.86. "Outside of a more positive USD view…we believe some of the tailwinds driving economic momentum in New Zealand (and the NZD more specifically) have now started to wane," Fiona Lake, strategist at Goldman Sachs wrote in a note.

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Firstly, the terms of trade – which measures the quantity of imports the country can buy with a set amount of exports – likely peaked in the first quarter of 2014 due to falling dairy prices.

New Zealand is the world's largest exporter of dairy products, which account for a quarter of the country's merchandise export earnings.

Average trade-weighted dairy prices have fallen 20 percent over the past two and a half months, driven by stronger global supply, and could fall further as China's inventory has reached elevated levels, the bank said.

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"While this will take some time to flow through to farm incomes and the economy more broadly, our forecasts incorporate an 11 percent fall in the terms of trade out to the second quarter of 2015," Lake said.

"This contributes to a meaningful slowing in national nominal income growth through 2015 and also generates a widening in New Zealand's current account deficit back towards 5 percent of GDP [gross domestic product] over the next 12-18 months," she added.

New Zealand's current account deficit stood at 3.4 percent of GDP in 2013. Second, economic momentum may begin to slow as housing market activity cools and the growth contribution from the 2011 Christchurch earthquake reconstruction peaks in the coming months.

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"By late 2014 we forecast New Zealand GDP to be growing at a more modest 1.6 percent annualized pace at a time when U.S. growth momentum is forecast to have lifted to 3.5 percent," she said.

The New Zealand economy expanded 2.7 percent last year, making it one of the fastest growing countries in the developed world. Finally, the Reserve Bank of New Zealand (RBNZ), which began a widely-anticipated tightening cycle last month may not raise interest rates as fast at the market expects.

"We continue to hold a more dovish expectation for the RBNZ's tightening cycle than the consensus," Lake said. Goldman expects further rate hikes to 3.25 percent by end of the second quarter, then a pause through year-end. The market is pricing in rates closer to 3.75 percent by year-end.

Taking the lead among developed economies in tightening monetary policy, the RBNZ last month lifted its official cash rate by 25 basis points to 2.75 percent, from a record low 2.5 percent.