What does our weaker currency mean for the economy?

In recent weeks and months, the NZ dollar has weakened against most trading partners.

It’s doing exactly what you’d expect it to against a challenging economic backdrop, and whether this is good or bad depends on your perspective.

The NZ dollar is down six per cent against the US dollar since the beginning of July, while it’s at a three year low against the Australian dollar.

We’re under 0.50 against the euro, something we haven’t seen since late 2009, more than 15 years ago.

Currency markets are where the growth outlook, inflation expectations and interest rate differentials all intersect.

Right now, New Zealand is in a tough spot.

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Our economy has been weak and the Reserve Bank has needed to reduce interest rates to help it.

That makes us a less attractive proposition for global capital, so money chooses to move elsewhere.

It’s an important shock absorber though, and a very effective one.

A weaker NZ dollar is a tailwind for the export sector, making us more competitive internationally and pushing up the value we get for goods sold overseas.

China is our biggest export market, while in recent years Australia and the US have been jostling for number two and three.

Like most commodities, dairy products are priced in US dollars.

When the NZ dollar is softer against the greenback, that feeds directly into calculations for what farmers might receive here at the farmgate.

The tourism sector is another beneficiary of a weaker currency, as we become a more affordable holiday destination.

Australia is our biggest market for international arrivals, and we look more enticing at A$0.88 than we did at A$0.94 back in April.

With the euro buying some 13 per cent more than a year ago on our shores, it’d be nice to see a few more German tourists too.

This added support for goods exporters as well as tourism should help the economy recover, boosting export incomes and lifting demand.

That improving backdrop should lessen the need for more rate cuts, and at some point it might justify the OCR heading back up again.

That’s not a bad thing if it comes on the back of an improving economy, rather than problematic inflation.

Speaking of inflation, it can be the other side of the weaker currency coin.

A lower NZ dollar leads to higher prices for imported goods, including fuel, raw materials and everything else we source from offshore.

Currency movements have a big impact on exporters, consumers and prices, while they also matter for investors.

For your investment portfolio or your KiwiSaver account, these can go against you or work in your favour.

In recent months, it’s been the latter.

Global markets have performed well (despite the recent volatility) and the decline in the NZ dollar has supercharged those returns further.

However, looking out 12 months or more this tailwind could become a headwind.

At US$0.57, the NZ dollar is almost 14 per cent below its 25-year average of US$0.66.

It’s also weaker against the Australia dollar, British pound and euro than it has been for much of the past decade.

If you believe in mean reversion, you’d say we should trend higher against all these currencies over the next year or two.

This is something to be mindful of, but currency moves shouldn’t drive our decisions.

It’s more important for investors to focus on great businesses with good prospects, wherever they happen to be.

The same goes for business owners, who can only do their best to manage currency risks.

There’s no perfect level for the NZ dollar.

Ideally, we want it low enough to keep our exporters competitive, but strong enough to maintain our purchasing power in the global marketplace.

A weaker currency is a double-edged sword, and the sweet spot is arguably a little higher than where we are right now.

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