NZ – Trade Weighted Index and the current account deficit

An index that measures the value of $NZ in relationship to a group (or “basket”) of other currencies – see image right. The currencies included are from NZ’s major export markets i.e. Australia, USA, Japan, Euro area, UK. – $A, $US, ¥, €, £. Each of the currencies included in the TWI is “weighted” according to how important exports to that country are (= % of total exports). From the TWI we can see if the $NZ has appreciated or depreciated against our major trading partners currencies overall.

Weakening NZ dollar and implications for current account Westpac Bank in their Economic Bulletin last week mentioned that since 2021 the NZD has fallen by over 5% on a trade weighted basis and by around 14% and 3% versus the key USD and AUD currencies.

So, what might that downside risk mean for the NZD? We can get a clue by considering that historical relationship between changes in the terms of trade and the exchange rate in down-cycles. So far, the cycle we are experiencing has been fairly moderate – similar to the falls seen in 2011/12 but less than experienced in the Global Financial Crisis period and in 2013/15 (when dairy prices, in particular, fell significantly). If we were to see export prices and the terms of trade fall further in line with those episodes – i.e., by another 4% or so – then the implication would be further weakening of the NZD. In such a scenario, we could see another 10% fall in the TWI and NZD/USD. We can see this in past downturns in the terms of trade where episodes involving larger NZD adjustments are associated with greater current account adjustment. This is because the underlying shock driving both the terms of trade and the exchange rate prompts weakness in domestic consumption and ultimately reduced imports and an improved trade balance – see below.

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