The New Zealand dollar's precipitous drop, triggered by the central bank's disclosure that it had intervened aggressively in the FX market, has investors questioning whether it faces a free fall.
On Monday, the kiwi dollar plunged nearly 2 percent to a 14-month low of $0.77 against the U.S. dollar, after data showed the Reserve Bank of New Zealand (RBNZ) sold a net 521 million New Zealand dollars in August. The sale – the largest in seven years – was a bid to lower the exchange rate, which has been a headwind for exporters.
With the RBNZ on a campaign to weaken the New Zealand dollar, the currency is appears to be a one-way bet over the longer-run, say strategists, but declines are likely to be orderly and gradual.
"Clearly, the risks are heavily skewered to downside, but I'm not expecting a free fall," Ray Attrill, global head of FX strategy at National Australia Bank (NAB) told CNBC on Tuesday.
One reason for this is U.S. dollar gains are set to slow, Attrill said, pointing out that the currency is overbought.
Secondly, continued losses in the New Zealand dollar may begin to revive expectations of a rate hike, which could support for the currency.
At the beginning of the year, expectations that the RBNZ would embark on a rate hike cycle fueled gains in the currency.
The central bank followed through with four rate hikes between March and July. However, in July, the central bank signaled an extended pause in future rate hikes on grounds that it needed to undertake a period of monitoring before considering further policy adjustment, taking steam out of the currency's gains. The kiwi dollar has since declined over 11 percent.
NAB expects the currency to end the year at $0.78, drift lower to $0.73 in 2015 and $0.68 by late-2016. The risk to these forecasts is that the RBNZ stages another major intervention, leading to a swifter decline.
Currency still overvalued
The kiwi dollar is down 5.1 percent against the U.S. dollar year-to-date, but remains overvalued by around 6 percent relative to its long-term real effective exchange rate, according to Barclays.
The central bank is not alone in its drive to lower the currency. Prime Minister John Key said earlier this week that the "goldilocks rate" is about $0.65, implying a further 16 percent depreciation from current levels.
Sean Callow, senior currency strategist at Westpac doesn't expect to see these levels anytime soon.
"We are starting to run out of obvious potential catalyst for sharp declines," said Callow.
"The central bank is going to cut rates, they have already confirmed intervention and the economy is still growing OK," he said.
The wild card is further intervention before year-end, said Callow, which could argue for another leg down in the kiwi dollar. Otherwise, the bank expects the currency to end the year in the mid-70s.