MORGAN STANLEY: The New Zealand dollar’s drop is about to get a whole lot bigger

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There’s likely to be a at least two further 0.25% interest rate cuts from the RBNZ, potentially three, with the drop in the New Zealand dollar likely to extend to 62c before year’s end.

That’s the view of Morgan Stanley’s Sung Woen Kang and Jessica Liang who, in a note following the release of soft June quarter CPI data earlier today, paint what can only be perceived to be a fairly bleak outlook for the once high-flying “rockstar” New Zealand economy.

Australians would be familiar with the term “capex cliff”, the unwinding boom in mining sector infrastructure spending following the recent sharp decline in commodity prices.

Well, in New Zealand it’s a little different, with Kang and Liang saying the Kiwi economy faces a “dairy cliff” amidst slumping global dairy prices.

Here’s their view:

“Most concerning of all is that global dairy prices continue to be sluggish, with both short and longer-dated contracts pointing to subdued recovery. In the latest auction, the GDT price index fell -10.7%, with whole milk powder falling by more at -13.1%, 17% and 22% below June meeting prices. Our China dairy analysts do not see any signs of meaningful manufacturers’ demand for milk powder in 2H15 due to yet elevated inventories, while the Chinese stock market’s sharp decline could put further downward pressure on world dairy demand, by suppressing once again Chinese demand for dairy which was about to recover.

Recently, we also saw that, in a sanctions exchange, Russia extended the food imports ban until August 5, 2016 following the decision of the EU foreign ministers to extend economic sanctions on Russia until January 31, 2016. Given Russia’s ban on imports of dairy products, this will also likely contribute to a prolonged slump in global demand. Furthermore, as auction volumes increase in seasonal fashion, this is likely to put further downward pressure on winning prices”.

That’s bad news for New Zealand’s economy which, like Australia and its reliance on iron ore export revenues, is highly-dependent on dairy prices for its economic fortunes.

According to Morgan Stanley, a prolonged period of lower dairy prices, along with a subdued outlook for both inflation and economic growth, would likely see the RBNZ take aggressive measures to help buttress the New Zealand economy.

“After the 25bp cut in its June meeting, we now expect the RBNZ to follow up with two further rate cuts this year. We expect rates to be lowered 25bp at each of the July and September meetings to bring the OCR down to 2.75%; we see a further 50% probability of an additional rate cut in 4Q15, depending on data developments”.

Like others in the market, Kang and Liang forecast that aggressive policy easing from the RBNZ, along with steady policy tightening from the US Federal Reserve, will weigh on the New Zealand dollar.

“The diverging cycles of the RBNZ and the Fed, would continue to put NZD under pressure, as the currency reacts from negative drags in dairy price moves and as we move closer to the first Fed rate hike. We look for NZD/USD to end the year at 0.62”.

And they aren’t alone in their pessimism towards the outlook for the currency. The National Australian Bank (NAB) suggest the Kiwi is in the midst of a “bleak midwinter”, forecasting the dollar to plunge to 60c against the US dollar by the end of the March quarter 2016.

Today, having hit a fresh six-year low against the US dollar, the NZD/USD exchange rate currently sits at .6511.