Potential for an OCR cut, or even RBNZ currency markets intevention seen; Aussie OCR cut expected; Potential for QE3 in the US rumbles on

Although the New Zealand dollar remains stubbornly high, it's unlikely to fall significantly anytime soon, and the unlikely event of Reserve Bank intervention in the currency markets to try and weaken it would have little impact, says HiFX senior dealer Dan Bell.

In a short statement issued on Thursday as the Reserve Bank left the Official Cash Rate unchanged at its record low of 2.5%, Governor Alan Bollard raised the possibility of central bank action to try and weaken the dollar.

“The New Zealand dollar has stayed elevated despite recent falls in commodity prices," Bollard said. "Should the exchange rate remain strong without anything else changing, the Bank would need to reassess the outlook for monetary policy settings."

Some economists took this as a suggestion the next move in the OCR could be down rather than up. However, Bell says the potential for currency market intervention has also raised its head.

The Reserve Bank did intervene in the currency markets on June 11, 2007 selling New Zealand dollars in an effort to weaken the kiwi, saying it regarded exchange rates at the time as "exceptional and unjustified in terms of the economic fundamentals." The Trade Weighted Index (TWI), which measures the kiwi against the US dollar, British pound, Australian dollar, yen and euro, was then at 74.12. Today it was at 72.30.

Although this is still high by historic standards, Bell doesn't expect the Reserve Bank to actually intervene again.

"It's not something they generally do because we just don't have the fire power to have a huge impact on the foreign exchange market," says Bell.

"I think for now it's more jaw boning than anything else. But we have seen the interest rate yields (swap rates) push down a little bit and perhaps that's going to have the desired effect in the long-term."

Against most currencies in the TWI -  including the US dollar, euro and British pound - the kiwi is strong but this reflects economic weakness elsewhere in the world.

"The TWI is still high but looking at what's happening in Europe and the UK where their interest rates are still very, very low and certainly there's no talk about tightening monetary policy settings there, it's difficult to see how the New Zealand dollar can really fall out of bed when you've got these other central banks prepared to keep these rates so low."

And in the US the possibility of QE3 remains

Then there's the US where speculation continues over the Federal Reserve potentially embarking on its third round of quantitative easing, or money printing.

"The New Zealand dollar versus the US dollar is really impacted more by what's happening in the US and what's happening with US monetary policy. As we know US interest rates are set at 0-0.25% , their central bank has undertaken a number of rounds of different monetary policy measures, IE printing money, and the New Zealand dollar versus the US has held up recently over US80c despite falling commodity prices and what is still quite an uncertain global outlook. So I struggle to see how we (the Reserve Bank of New Zealand) can do a lot."

"Certainly talking about the potential to use monetary policy and cut the official cash rate, I think that's about as much as they (the RBNZ) would be prepared to do," adds Bell.

Importantly, against the Australian dollar, the kiwi was now trading a bit lower - around A78c.

"Australia's our largest trading partner so the fact that we continue to have a weaker currency against the Australian dollar is a good thing for our exporters," Bell says.

As for the Fed, in a media conference after this week's Federal Open Market Committee meeting, chairman Ben Bernanke hinted - again - at the possibility of a fresh round of money printing.

"Ben Bernanke commented they would be prepared to use their balance sheet and undertake further quantitative easing if they need to. I think that's pretty much keeping to the script. If the US economy was to fall back into another recession, the US really doesn't have any other choices. They can't drop interest rates any further. The only option they have is to get the printing press out."

"Naturally if we hear from the US central bank at any stage this year again that they're going to be willing to print, then the New Zealand dollar will rally against the US and that's just a fact of how it's playing out at the moment."

US$2.3 trillion and counting

Another round of quantitative easing, which would be the third, would follow the first two rounds worth US$2.3 trillion.

It was initially done through emergency liquidity schemes and direct loans to banks at the beginning of the global credit crunch in 2008. The Fed then moved on to purchases of mortgage-backed securities and agencies debt, and some US Treasuries (so-called QE1) which cost a total of US$1.7 trillion, in November 2008. It then embarked on more purchases of US Treasures (so-called QE2 costing US$600 billion) in 2010 and 2011. The Fed has held official interest rates at 0% to 0.25% since December 2008 and says an "exceptionally low level" of rates is likely until at least late 2014.

Looking ahead to next week, the Reserve Bank of Australia is widely expected to cut that country's Official Cash Rate by 25 basis points to 4% on Tuesday afternoon. Expectations of a rate cut were heightened this week after data showed Australia's first quarter Consumer Price Index rose just 0.1%.

The European Central Bank is expected to leave official interest rates in the troubled Eurozone at 1% on Thursday night New Zealand time, and the French presidential election will be watched closely.

"At the moment (incumbent) Nicolas Sarkozy is expected to lose," says Bell. "There could be some political uncertainty come into the European situation given that France and Germany are the two countries that could have some impact on the developments in Europe towards more fiscal unity."

The second round of voting in the election is on Sunday, May 6 with the conservative Sarkozy polling behind Socialist Party presidential candidate Francois Hollande.

To subscribe to our free daily Currency Rate Sheet and News email, enter your email address here.

------------------------------------------------------------------------------------------------------------------------------------------

Dan Bell is the Senior Dealer at HiFX, a UK-headquartered foreign exchange dealer with significant operations in Australia and New Zealand. It has a dealing room in Auckland. See more detail here.