We believe that a new era of stubbornly low underlying inflation will prompt policymakers to cut interest rates in Australia from 1.75% now to 1.00% next year and to reduce rates in New Zealand from 2.25% to 1.50%. The problem is that hardly any inflation is being imported from overseas and there is very little price pressure in each economy’s domestic labour market. Underlying inflation in Australia may stay below the 2-3% target range for three years and in New Zealand it could stay close to the bottom of the 1-3% target range for almost as long. If we are right in thinking that interest rates in both Australia and New Zealand will fall by more than the markets expect while they rise faster than expected in the US, then both the Australian and New Zealand dollars could weaken from above US$0.70 now to around US$0.65.
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