NZ$ fall shows FX markets recognise NZ's falling commodity prices, soft local data, EU risk; Fall in line with fundamentals, RBNZ's Bollard says

Foreign exchange markets appear to be recognising New Zealand's falling commodity prices, softer local economic data, and the riskier environment in Europe, as they push the New Zealand dollar lower, Reserve Bank Governor Alan Bollard says.

The New Zealand dollar has fallen to its lowest level since mid-January against the US dollar. At 78.7 US cents currently, it is down from 82.3 US cents at the end of April, and this year's peak of 84.7 US cents at the end of February. The dollar had hit a post-float peak just over 88 US cents in August last year before falling to 73.6 US cents in November 2011 on fears about the European sovereign debt crisis. The Trade Weighted Index has fallen around 3.5% from 73 to 70.5 in the last two weeks.

Although the high currency has helped the Reserve Bank contain inflation pressures, it has frustrated the Bank, which thinks it is overvalued compared to fundamentals. Quantitative easing policies from central banks around the world has seen a flood of money into New Zealand dollar assets, pushing the currency up as global investors search for higher yields than in their local markets.

Last month, Bollard said if the New Zealand dollar remained elevated, and no other economic settings in New Zealand changed, then the Reserve Bank would reassess its outlook for where interest rates were headed. Markets interpreted this as meaning the Reserve Bank would look at cutting the Official Cash Rate from its record low of 2.5% if the dollar remained strong.

Speaking on Wednesday at the Bank's May Financial Stability Report, Bollard said the Reserve Bank had noted the New Zealand dollar "over the last week or two has been falling a bit, as has the Australian dollar."

“That’s presumably a response to a number of things, one of which is a risk-off environment in Europe, but also a recognition by the FX markets about our softer commodity prices and a few bits of softer data in Australia and New Zealand," Bollard said.

“So that’s been moving in a direction that we would have thought is broadly in line with fundamentals," he said.

Currency intervention

Meanwhile, appearing before Parliament's Finance and Expenditure Select Committee on Wednesday afternoon, Bollard was quizzed by Opposition Parties Labour, the Greens and New Zealand First about the high New Zealand dollar, and the Reserve Bank's ability to invervene to try and bring the dollar down.

Norman noted comments from the International Monetary Fund that Swiss exchange rate intervention had been an appropriate response for dealing with the high franc.

“As we’ve always said, the Swiss approach is quite an unusual one, because there they are, they’re an enclave with their own currency, and well-managed, in a Eurozone which is in a very sad state," Bollard replied.

There had been huge capital inflows into Switzerland, partly because of its economic performance but also partly because of its banking system.

“It’s an economy with almost no inflation, so they haven’t had to worry about sterilisation in their interventions. But having said that, they did take an unconventional approach, and it has partly worked for them, but at a high cost,” Bollard said.

Norman raised issue of the cost of the Swiss programme, saying the Swiss central bank was printing billions of francs, to buy slightly fewer euros, to keep the franc at a certain level.

“If at a certain point in the future their currency gets worse and they try to buy francs back again they’ll end up with less francs than they started with. But from their point of view, they started off with nothing, printed a whole bunch of francs, and they now have a whole bunch of euros...so when you say they’re going to take big losses, they’re just paper losses. They’re not real losses from the point of view of the Swiss Central Bank,” Norman said.

Bollard said that depended on how long the central bank was prepared to hold on to those euros.

“And of course they must follow international accounting standards, with their mark-to-market requirements. So you can call them paper losses, but I wouldn’t imagine a central bank would feel too comfortable incurring very large losses on a long basis.”

NZ First leader Peters raised the point that the IMF had recently noted the New Zealand dollar could be overvalued by 20%. He asked about the Bank's ability to intervene in the FX markets to bring the NZ dollar down.

“We don’t think that there’s very much that can be done where the benefits would outweigh the distortionary costs of doing things. We’ve spent a lot of time looking around the world at different measures, we’ve talked many times about the classes of things that are going on," Bollard said.

“We see very little that would work for New Zealand, other than the very limited intervention policies we’ve got currently. We think that a lot of this distortion is coming from quantitative easing from major economies, there’s not much we can do about that. We think this is going to gradually improve over time," he said.

“There’s now quite a lot of other economies who do have freely floating exchange rates, although of course a lot of them are complaining at the moment as well. If we could find a tool that improved, we wouldn’t hesitate to use it. But we think everything we’ve heard about has got some downside problems.”

Asked about currency controls run by the Singapore government, Bollard said that policy was an unusual one, where Singapore ran its exchange rate targeting system to try and achieve price stability.

“It of course is an economy that couldn’t be more different from New Zealand. It’s a world hub. We’re a world primary producer. We’re totally different,” Bollard said.

Overvalued, over-traded

“We want to see the highest currency that is consistent with our competitive position on a long-term sustainable basis. Because that is a measure of New Zealand’s richness compared to foreigners. But as it’s reflected around the room, we do think we’ve been in a higher level in recent months than that," Bollard said.

Asked by Peters why the New Zealand dollar was one of the most highly traded currencies in the world – about eleventh or twelfth – Bollard said the more trading of a currency there was, the deeper the market and the more liquid the currency should be.

“There should be some advantages out of that. But that’s not to say that there aren’t clearly positions being taken that have got no particular relationship to New Zealand’s competitive position or, of course, to our trading needs," Bollard said.

“We still have this exchange rate which is a lot higher than most. It has meant that we’ve always been able to get funding, whether it from the Japanese housewife, or East Asian central banks, or European markets," he said.

Labour’s David Parker picked up on the amount of trading of the New Zealand dollar, asking whether demand for the New Zealand dollar due to its high amount of trading added a margin to its level.

Reserve Bank Deputy Governor Grant Spencer said one of the factors behind New Zealand being a highly traded currency, despite the small size of the economy, was that most other small countries did not borrow in their own currency.

“New Zealand has the advantage that foreigners are willing to lend to us in New Zealand dollars. And that means we don’t take currency risk in our borrowing,” Spencer said.

Companies and banks were able to borrow in New Zealand dollars, whereas creditors would tell other small countries they wouldn’t lend to them in their local currency, but would lend US dollars and those countries would have to manage the currency risk themselves.

“But in New Zealand, the banks and others don’t have currency risk, so that’s a very positive thing. But one of the implications is there is a lot of trade in New Zealand dollars out there, part of it is just because we’re hedging our borrowing. That’s why we are up the ranking,” Spencer said.

Parker said an experienced economist had told him one reason the currency stayed high was people traded it so much because New Zealand settings were so predictable, and therefore if someone needed to put funds somewhere short-term, it was low risk to put them into New Zealand dollars.

Spencer said New Zealand had a slight positive interest rate, which may attract some carry trade flows (where someone borrows US dollars at a low interest rate and invests in New Zealand dollar assets at a higher interest rate).

“But generally we are a small currency and the money will be invested here because we are viewed as one of the growth prospects. People look around and say, where’s a country that has a liquid market and also a prospect for growth in the medium term?

“We’re one of the countries that come up. So we’re a victim of our own reasonably good prospects in that sense. We’re viewed as reasonably safe, and with some outlook for growth,” Spencer said.

Bollard said monetary policy settings in New Zealand were set for stability.

“But let’s remember why we need funds from overseas. It’s because New Zealanders borrow and haven’t saved. So ultimately that’s going to be the root cause,” he said.