© Reuters. FILE PHOTO: Illustration photo of a New Zealand Dollar note
By Charlotte Greenfield and Ana Nicolaci da Costa
WELLINGTON (Reuters) – Investors in New Zealand's financial markets are suddenly having to price in political risk after a decade of stability, as a nailbiting election race looks set to trigger a shake-up of economic and monetary policy.
The New Zealand dollar slumped to a three-month low on Thursday after an opinion poll showed the opposition Labour party, had unexpectedly grabbed the lead from the incumbent National party ahead of the Sept 23 election. Labour's support has been climbing since it picked 37-year old Jacinda Ardern as its new leader last month.
"This election could have quite a dramatic impact on the economy, whereas most elections really don't," said Paul Dales, chief Australia and New Zealand economist at Capital Economics.
Labour's platform includes cutting net migration by more than a third from record levels of 70,000 a year to reduce strains on infrastructure. It has also proposed changing the charter of the Reserve Bank of New Zealand (RBNZ), the nation's central bank, by ending its sole focus on inflation and adding an employment goal.
The National party is unlikely to get enough votes to form a government without support from the smaller New Zealand First party, which also wants lower immigration and changes to the way the RBNZ manages policy.
"Given the heightened domestic political uncertainty and prospects of significant policy changes by the next government, our base case for the kiwi dollar is to trade with a negative bias ahead of the elections," ING's London-based foreign exchange strategist Viraj Patel said in a report.
The currency had risen as far as $0.7557 in July, its highest level in more than two years, when the government's re-election for a fourth term seemed likely.
But as the race tightened, and expectations of interest rate hikes have been pushed further out, the kiwi has taken a spill.
Last month, it fell 4.5 percent against the U.S. dollar to be the worst performer amongst major currencies, and badly underperformed its Australian counterpart. The New Zealand dollar was the 11th most traded currency in the world in 2016, according to the Bank for International Settlements.
Support for Labour has jumped to 43 percent, its highest since 2006, overtaking National at 41 percent, a poll commissioned by 1 News showed on Thursday.
The introduction of a dual-mandate for the central bank would be one of the biggest changes for the RBNZ since it became the first central bank in the world to introduce an official inflation target in 1989.
Analysts say a full employment mandate alongside a 1-3 percent inflation target could lead to easier monetary policy, or a slower pace of tightening. The perception of a greater tolerance of inflation could also lead to a rise in bond yields.
"From the market point of view there's uncertainty. You don't know what the overriding priority will be," said Don Brash, who was the RBNZ governor in 1989 and later led the National Party in opposition. "That's going to lead to some loss of confidence in the New Zealand dollar."
If a shift in the central bank's mandate were to delay expected interest rate hikes, it could also feed through to the profit margins of major banks, who largely raise funding in offshore wholesale markets.
"Investors want a stable platform, they don't want to see someone come in and rock the boat too much… if someone came in disrupting that base it would make it more expensive for us to borrow money," said Stuart Ive, Wellington-based dealer at OM Financial.