Bank of New Zealand raises interest rates

Earlier today, the Bank of New Zealand raised its short-term interest rate a quarter-point to an all-time high of 8 percent in an attempt to combat rising prices for both consumer goods and housing.

The currency rose to a multi-decade high, breaching the US$0.75 level against the U.S. dollar - it's been a wild ride for many foreign currencies over the last year and the Kiwi's has been one of the wildest.


Bloomberg reports:

"A sustained period of slower growth in domestic activity will be required to alleviate inflation pressures,'' Reserve Bank Governor Alan Bollard said in Wellington today. A 60 percent surge in world prices of dairy products the past six months has boosted farmers' incomes and will stoke inflation next year, he said.

Bollard's third rate increase since March is buoying New Zealand's dollar as investors are attracted to a benchmark rate second only to Iceland's among countries with the highest credit rating. The yield gap with Japan widened to 7.5 percentage points, boosting returns for investors who borrow yen to invest in New Zealand dollars, known as a carry trade.
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Bollard isn't alone in raising rates to combat inflation. The European Central Bank yesterday raised its benchmark to a six-year high of 4 percent. The Bank of England's benchmark rate is at a six-year high of 5.5 percent after four increases in the past year, most recently on May 10.

The Reserve Bank of Australia yesterday left its benchmark at a six-year-high 6.25 percent. Futures traders have priced in another Australian increase by the end of this year, which would take the rate to a 10-year high.

With a booming economy, the Australian Dollar has also headed higher in recent months and, with today's stellar jobs report, both the exchange rate and interest rates will likely go even higher in Australia.

For both New Zealand and Australia, higher interest rates will create even more demand for the currencies from hedge funds employing the carry trade where firms borrow at low interest rates (e.g., Japan at 0.5 percent) and exchange these funds for higher yielding currencies (e.g., New Zealand at 8 percent and Australia at just over 6 percent).

A stronger currency makes exports more expensive and imports less expensive, slowing the economy and dampening domestic prices - at least that's the way it's supposed to work.

The Loonie looks pretty good too as the Bank of Canada gets ready for rate increases.


So far in 2007, foreign currencies have been a very good investment as the combination of higher overseas interest rates and currencies that are strengthening against the dollar provide returns far in excess of domestic savings accounts.

The foreign currency certificate of deposit held in the model portfolio at Iacono Research has gained ten percent since it was recommended to subscribers in January.