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Currency Market Analysis

Sep 21, 2020 | Currency Market Analysis

Global Themes

Will the election impact the NZD?

• Supply v demand side policies
• Exploring the dynamics
• What is the likely outcome?

Supply v demand side policies

The October 19 election is shaping as a tighter contest than might have been expected a month ago. In terms of currency impact the key is whether demand side or supply side policies prevail. On one hand the leading Labour Party and the Greens support increased spending to drive aggregate demand higher. On the other hand the National Party and Act are pursuing a platform of lower taxes to increase the supply of money into the economy. New Zealand First are an eclectic mix of both, but with their pitch for lower cigarette taxes and smaller government are generally more aligned with supply side policies.

Higher spending on infrastructure effectively results in more money chasing more goods. While that’s still a positive for inflation it’s more designed to boost employment and GDP through direct investment. Lower taxes on the other hand is often more money chasing a similar amount of goods. Over time it is hoped this approach drives up aggregate demand, but overall supply side policies (ie. lower taxes) generally tend to be the more inflationary of the two paths, at least in the immediate.

Exploring the dynamics

The other less discussed aspect of fiscal policy is the projected impact on confidence. In a scenario of increased spending studies have shown businesses might be less prone to invest for the future if higher taxes will accompany such spending. On the other hand lower taxes imply less government spending down the track which aside from companies that service the public sector, appears less of a drain on confidence. The net result? Business confidence seems higher under the rule of supply side proponents (eg. National/Act coalitions).

Overall that mix of higher inflation plus higher business confidence suggests to us that the election of a National/Act government would boost the New Zealand Dollar. The return of a Labour/NZ First Government would obviously preserve the status quo. On the other hand the return of a Labour/Greens coalition might add further downside to the Kiwi given both are more inclined to back higher investment with higher taxes, which might place further pressure on the Reserve Bank to pursue more expansionary monetary policy.

What is the likely outcome?

The political polls have Labour still well ahead, so one factor that we haven’t considered is Labour governing on its own. But history is against that - never since the beginning of MMP in the mid 1990s has one party had the numbers to go it alone - even John Key couldn’t manage that in the landslide 2014 election. Moreover our prediction is for a strong rise at the extremities, as both major parties disappoint the devout by trying to win the middle. That has us seeing Act and the Greens with significant increases, but we also expect NZ First’s unique blend of populism to fare better than current polling suggests. Perhaps the pollsters don’t bother checking in with the over 70s.

Put together that suggests to us that the return of a Labour/NZ First or Labour/Greens coalition looks the most likely outcome. That carries a slightly negative currency bias into the election, although there’s plenty of time still for opinions to change. Analysts at Citibank however agree with that outlook, adding in renewed dovishness by the RBNZ to firm up their target of 0.64-0.65 on NZD/USD for the month ahead. On the RBNZ, they are our major focus this week when they make their latest announcement on Wednesday. For the very reason of that pending election we think they’ll give us very little by way of new policy until November, but we’ll take a closer look at that meeting on Wednesday. Fingers crossed for an easing in lockdown restrictions later today.

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