US spending cuts or even default won't necessarily push NZ interest rates up because NZ becomes more attractive, PM Key says

Weakness in the United States economy from the government there cutting spending or defaulting on its debt will not necessarily raise New Zealand interest rates, Prime Minister John Key says.

Meanwhile, if the US government does not sort out its debt ceiling negotiations, the New Zealand dollar is likely to keep rising against its US counterpart as investors turn away from the US dollar. And despite investors increasingly seeing New Zealand in a better light relative to the US, a default by the world's biggest economy would would send shockwaves through the global economy, affecting New Zealand, Key said.

Speaking on TVNZ's Breakfast programme on Monday morning, Key said the situation in the US, where policy-makers appear to have agreed on a framework for raising its debt ceiling, while immediately cutting about US$1 trillion of spending, could be positive for New Zealand because our economy appeared to be in a better shape.

"The biggest and most obvious place where it manifests itself is a higher New Zealand-US exchange rate, and we’ve already seen that move, and you’ve seen it this morning through 88 cents," Key said on Breakfast

"That’s simply because, like any currency pair, it’s like a see-saw – one goes up and the other goes down, in this case the US, they [investors] do not like the US economy at the moment and we’re going up,” Key said.

“From an interest rate point of view it doesn’t necessarily force New Zealand interest rates up, because actually funnily enough we become even more attractive, and so more capital wants to flow in," he said.

"The big risk for New Zealand is the risk that’s sitting out there, and that is that the US economy continues to grind along, the US has to stop spending, that slows the global economy down. You’ve already got a weak position in Europe with Greece and Portugal and other countries. The risk here is that global sentiment is weak, and that affects our markets.”

They were confident...but...

The sense in the United States over the last few weeks was palpable, Key said.

“When we were in Washington, which was 10 days or so ago now, they were very, very confident that they would get a deal. The general view from Secretary Geithner from the Treasury, or Ben Bernanke, Federal Reserve President, President Obama, it was just unthinkable not to get a deal,” he said.

“But as we get nearer and nearer [to August 2], obviously everyone’s staring to stare down the barrel of what that might mean, and when we were on holiday [last week] the front page of the paper was, ‘the 30 things that will happen to you as an American if we default.’

“It was: lose your job, interest rates going up - it was just a nightmare. If you’re on food stamps they mightn’t turn up, if you’re a service man or woman you might not get paid, there’re real life issues here.”

Even if US policy makers got a deal in place by August 2 to raise the debt ceiling, the US government would be borrowing even more and forced to cut spending as part of that deal.Cutting spending could have the effect of slowing the US economy, while a default could see investors turned off the US as they looked toward countries like New Zealand.

“What it all demonstrates is, without getting deeply political, we’ve been on the right track. We had a zero budget this time, we get back into surplus in a couple of years, we’re paying off our debt,” Key said.

“Our debt tops out at substantially lower levels than the United States. We’re at under 30% [net debt as a percentage of GDP], they’re at 70 on their way to 90%. So all up we’re doing the right things here,” he said.

High exchange rate helps control inflation

Key was asked whether hiking interest rates in New Zealand would hurt the economy, with high inflation and the country's second largest city still in ruins.

“It’s worth remembering what the Reserve Bank governor did. He cut interest rates from 3% to 2.5% as a base rate to reflect what was happening in Christchurch,” Key said.

“Secondly, if you think about our inflation rate, while it’s 5.3% technically, you have to take the GST increase out because that flows out and the Reserve Bank governor looks through it. So net on net, our inflation rate is running at around about 3%, but likely to drop back to 1.5%,” he said.

“If the exchange rate stays high, that takes some pressure off imported inflation – petrol prices are lower, imported prices are lower. That does take some pressure off the Reserve Bank governor.”

Asked about stagnant wages while inflation rose, Key said the number one thing the government could do was help protect jobs.

“If you go back and have a look at where we’re at, and where we’ve come from, that’s why the government has been basically solely focussed in the last three years on trying to build our economy and build our competitiveness,” Key said.

“And we’ve done a pretty good job on that front. You look at our unemployment rate, [it] is 6.6% and falling. In the US their unemployment rate is 9.2% and their unofficial unemployment rate’s about 13 or 14%.,” he said.

NZ$ could keep rising

Meanwhile on Newstalk ZB this morning Key said the New Zealand dollar could continue to rise against the US dollar if debt ceiling negotiations dragged on.

“You would expect our exchange rate to track even higher. You’ve seen the New Zealand-US exchange rate moving up on the back of the concern that the financial markets have - that the US might not get a deal done," Key said on ZB.

However a US default would send shockwaves through the global financial system, with repercussions for New Zealand.

(Updates with Newstalk ZB comments, further comments from Key on Breakfast)