Economic Overview

New Zealand is a very small economy with GDP valued at approximately US$50bln in 2001. The country's population is actually equivalent to less than half of the population of New York City. It was once one of the most regulated countries within the OECD (Organization for Economic Co-operation and Development), but over the past two decades has been moving towards an open, modern and stable economy.

New Zealand also has highly developed manufacturing and services sectors, with the agricultural industry driving the bulk of the country's exports. The economy is strongly-trade oriented, with exports of goods and services representing approximately one third of GDP. Due to the small size of the economy, and its significant trade activities, New Zealand is highly sensitive to global performance, especially that of its key Asian trading partners, Australia and Japan. Together, Australia and Japan represent 30% of New Zealand's trading activity. During the Asian Crisis, New Zealand's GDP contracted by 1.3% as a result of reduced demand for exports, and two consecutive droughts, from reduced agricultural and related production. The following are a breakdown of the New Zealand's most important trading partners:

Monetary & Fiscal Policy Makers

The Reserve Bank of New Zealand (RBNZ) is the monetary policy authority of New Zealand. Meetings on monetary policy occur eight times a year or approximately every six weeks. Unlike most other central banks, the decision for rate changes rests ultimately on the bank's governor. The current Policy Target Agreements set by the Minister and the Governor focus on maintaining policy stability and avoiding unnecessary instability in output, interest rates and the exchange rate. Price stability refers to maintaining the annual CPI inflation at 1.5%. If the RBNZ does not meet this target, the government has the ability to dismiss the Governor of the RBNZ, though this is rarely done. This serves as a strong incentive for the RBNZ to meets its inflation target. The most common tools used by the RBNZ to implement monetary policy changes are the following:

Official Cash Rate (OCR): This is the rate set by the RBNZ to implement monetary policy. The Bank lends overnight cash at 25 basis points above the OCR rate and receives deposits or pays interest at 25 basis points below this rate. By controlling the cost of liquidity for commercial banks, the RBNZ can influence the interest rates offered to individuals and corporations. This effectively creates a 50 basis point corridor that bounds the inter-bank overnight rate. Banks offering funds above the upper bound will attract few takers, because funds can be borrowed for a lower cost from the RBNZ. Also, banks offering rates below the lower bound will also attract few takers, because they are offering lower yields than the RBNZ. The official cash rate is reviewed and manipulated to maintain economic stability.

Open Market Operations: This is used to meet the cash target. The cash target is the targeted amount of reserves held by registered banks. The current target is NZ$20 million. The RBNZ prepares forecasts of daily fluctuations on the cash target and then will use these forecasts to determine the amount of funds to inject or withdraw in order to meet the cash target.

Important Characteristics of the New Zealand dollar

Strong correlation with AUD - competition with Australia

Australia is New Zealand's largest trading partner. This coupled with the proximity of the countries and the fact that New Zealand is highly trade oriented, creates strong ties between the two countries. When the Australian economy does well and Australian corporations increase their importing activities, New Zealand is one of the first to benefit. In fact, since 1999, the Australian economy has done very well, with for example, a booming housing market that created a need to increase imports of building products. As a result, this strength translated into Australia importing 10% more goods from New Zealand between 1999-2002.

Commodity linked currency

New Zealand is an export driven economy with commodities representing over 40% of the country's exports. As a result, the currency has a 50% positive correlation with commodity prices. As commodity prices increase, the NZD will also appreciate. The correlation between AUD and NZD also contributes to the NZD's status as a "commodity linked" currency. AUD economic performance is also highly correlated with commodity prices. Therefore, as commodity prices increase, the Australian economy benefits, translating into increase activity in all aspects of the country's operations, including trade with New Zealand.

Carry trades

With the highest interest rate of the industrialized countries, the NZD has been one of the most popular currencies to buy for carry trades.

Interest rate differentials between the cash rates of Australia and the short-term interest rate yields of other industrialized countries are closely followed

Interest rate can be good indicators of potential money flows as they indicate how much premium yield NZD short term fixed income assets are offering over foreign short term fixed income assets, or vice versa. This differential provides traders with indications of potential currency movements, as investors are always looking for assets with the highest yields.

Population Migration

New Zealand has a very small population. Therefore increases in migration into the country can have significant effects on the economy. Between 2002-2003, the population of New Zealand increased by 37,500 people versus an increase of 1,700 between 2001-2002. This strong population migration into New Zealand has contributed significantly to the performance of the economy, because as the population increases, the demand for household goods increases, leading to an increase in overall consumer consumption.

Severe weather conditions such as droughts, negatively affect Australia's economy

Since the bulk of New Zealand's exports are commodities, the country's GDP is highly sensitive to severe weather conditions that may damage the country's farming activities. In 1998, droughts cost the country over $50MM. In addition, droughts are also very frequent in Australia, New Zealand's largest trading partner. These droughts have cost Australia up to 1% in GDP, which also translated into a negative impact on the New Zealand economy.

Important Economic Indicators for New Zealand

  Gross Domestic Product (GDP)

  Consumer Price Index (CPI)

  Producer Price Index (PPI)

  Balance of Goods and Services

  Private Consumption