IThe central bank in New Zealand has once again raised the key interest rate. This makes it interesting to resume an earlier investment strategy: the so-called carry trade, taking cheap credit to other countries in the region and then investing it in “Kiwi dollars” at a good interest rate. And following the hike in interest rates in Australia, the Australian dollar is also becoming more interesting to interest rate and currency speculators.
According to an analysis of carry trades written by the Reserve Bank of Australia (RBA), “the total return of such a strategy can vary widely depending on exchange rate fluctuations:” due to relatively low exchange rate volatility from 2003 to 2007. During the period, carry trades were very profitable, with exchange rate fluctuations between major carry trade currency pairs often adding to returns, as the Australian and New Zealand dollars appreciated against the Japanese yen.
Inflation at highest level in more than 30 years
New Zealand’s Reserve Bank is aggressively raising interest rates after months of loose monetary policy. Within ten months, the prime interest rate increased to 2.75 percent. On Wednesday, monetary officials raised the key interest rate by 50 basis points to 3 per cent. This move was expected. However, there was a more significant statement for the markets. Here, the Reserve Bank of New Zealand (RBNZ) states that it expects longer, higher inflation – and thus higher levels of the prime interest rate. In their current forecast, monetary watchers now see the key interest rate (“overnight cash rate”, OCR) to have peaked at 4.1 percent in the second quarter of next year. As recently as May, central bank governor Adrian Orr said he was expecting a peak of 3.95 percent in the third quarter of 2023. He now believes that the prime interest rate will only decrease gradually from 2024 onwards. While the New Zealand dollar gained on the decision, its Australian counterpart ‘Kiwi’ fell 0.3 per cent as speculators are more likely to keep an eye on Wellington following the interest rate decision.
Central bankers in New Zealand face a difficult task: the rate of inflation is 7.3 percent, the highest in more than 30 years. The central bank raised its inflation rate forecast for the fourth quarter to 5.8 per cent from 5.5 per cent earlier. In 2024 itself, it will reach in the range of 1 to 3 per cent. However, unemployment rates are rising and house prices are falling slightly, while consumption is still alive and has supported growth so far. The RBNZ should not stop to avoid a downtrend. Goldman Sachs estimates that New Zealand is at risk of a recession of 30 to 35 percent within 12 months.
Those who rely on carry trades should be fine, as long as other countries – such as Japan or China – keep key interest rates and thus lending rates low. “The ability to generate positive returns from a carry trade strategy stems from the failure of open interest rate parity,” explains RBA.