Interest Rates May Hold


Statement from ASB

“This week’s events will be dominated by reaction to Standard & Poors’ (S&P) downgrade of the US long-term sovereign credit rating from AAA to AA+. The other ratings agencies, Moodys and Fitch, had somewhat reluctantly confirmed the US AAA rating after the recent debt deal was reached.

S&P downgraded the US’s sovereign credit rating because it fell short of what it calculated was necessary to stabilise the government’s medium-term debt dynamics. But the increasingly fractured state of US politics was another key reason. Many watching the US debt ceiling saga would probably perceive children in a sandpit as having a better chance of sharing their toys than the US houses of government have of coming to a sensible fiscal compromise.

So what does the rating downgrade mean? While a downgrade from S&P seemed probable, the decision is in some sense a step into the unknown. The US AAA rating dates from 1917 (from Moody’s) and 1941 (from S&P).

The initial impact on the NZD and AUD is somewhat ambiguous. Global sharemarkets are likely to fall sharply today (US S&P futures are down over 2% at time of writing). Since the NZD tends to be aligned with global financial market sentiment, downward pressure on the NZD may well be the initial outcome over Monday. It will take 24 hours for global time-zones to open up for trading on Monday morning. Participants should prepare for at least 72 hours of volatility, because it will take a few days for the full implications of the loss of the US’s AAA sovereign rating to be digested. By the end of the week, the decline in the USD could well lead to a higher NZD. The medium-term impact is likely to be a slightly weaker USD than otherwise, reinforcing the upward structural shift in NZD/USD.

At this stage we continue to expect the RBNZ will in September take back March’s insurance 50bp OCR cut. However, the risks have grown over the past week that the RBNZ will delay that hike. How the global financial risks evolve over the next month will be a key influence on whether the RBNZ hikes in September, with a hike contingent on receding global financial risks.

To a large extent the US downgrade is a sideshow to the main source of debt concern, which is in Europe. Italy has been under the gun as markets focus on its high level of debt and relative inaction. The Italian Government has now pledged to get its (relatively modest) budget deficit back into balance by 2013, a year earlier than originally planned. That is a small step to alleviating investor concern. But Europe’s politicians – usually

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