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The Mounting Inflation Pressure in New Zealand

|Includes:CUT, iShares MSCI New Zealand Capped ETF (ENZL)
The 2010 December quarter CPI of New Zealand has grown by 2.3% from the September quarter, which is the largest quarterly increase in more than 20 years. The latest December quarter CPI growth rate is also 4% over December 2009, the highest in seven quarters. 
New Zealand has traditionally been seen in the same asset group as Australia in the currency market. New Zealand is geographically close to Australia. The major export items of New Zealand include commodities such as meat, milk powder, and wood. Both countries heavily rely on East Asia as their major export destination. The correlation between AUDUSD and USDNZD is -0.92 in 2010. 
Chart 1: AUDNZD Since 2010
 Click to enlarge
So far in 2010, the external demand for New Zealand goods is quite strong. New Zealand is likely to end 2010 with the trade surplus at the first time since 2002. The top export destinations of New Zealand include Australia, China, Japan, and the US. The largest customer of New Zealand exports, Australia, just has experienced one of the worst natural disasters in its history. The reconstruction needs will actually be a boost for New Zealand export items such as wood, metal, and agricultural goods.  
Exports from New Zealand to the US and Japan have steadily dropped over years. However, China’s import rose fast and pick up the slack. The biggest items that China purchased from New Zealand include dairy products and wood. Due to concerns over its domestic supply, China’s import of dairy products from New Zealand rose by 300% to NZD 1.6 billion in 2010 from 2007, higher than the import value of next three countries combined (Australia, the US, and Japan). The second biggest item that China purchased from New Zealand is wood, which is also in short supply domestically in China due to the increasingly strict rules against logging. New Zealand wood export to China increased by more than 200% from 2007 to 2010. Although China is going to tighten its monetary and fiscal policies to fight inflation in 2011, its demand for major New Zealand exports will not be affected as the demand shift to New Zealand’s exports is structural and not easy to be replaced.
Chart 2: Commodity Prices of New Zealand Exports
Source: The Reserve Bank of New Zealand
While New Zealand economy is relatively small, it recovered fast from the financial crisis in 2008. New Zealand also is among one of the few developed economies that began to raise rate after the crisis. The unemployment rate steadily dropped to 6.4% in September 2010. In 2010, the Reserve Bank of New Zealand had raised the official interest rate twice from 2.5% to 3%, while the y-y inflation rate ranged between 1.5% and 2% during the same period. The latest extraordinary CPI is already higher than 1%-3% range required in the Policy Targets Agreement (PTA) defined by the Reserve Bank. I believe that the market’s expectation for the rate raise in the next few weeks is set to grow.    

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Stocks: ENZL, CUT