By Roger J Kerr
While the G7 and G20 groups of nations confuse themselves over whether exchange rate intervention/manipulation is a good thing or a bad thing, there is no getting past the reality that the NZ dollar exchange rate value and movement has an enormous influence on the NZ economy.
Income levels and jobs in the economy are largely dependent on the competitiveness and success of our big export industries.
The exchange rate is just as important as costs and selling prices for exporters in this respect.
On the other side, import penetration is much higher in NZ than other OECD countries; therefore the exchange rate has a huge influence over inflation, as we saw in the December quarter’s CPI numbers.
Not so many years ago domestic monetary policy settings via interest rate changes drove the movements of the NZD/USD exchange rate. Today, in the aftermath of the GFC the opposite is occurring.
It appears that the NZ dollar is determining the level of short term interest rates in New Zealand.
There is no way the RBNZ will increase short-term interest rates while the Kiwi dollar (as measured by the TWI) is at such elevated levels.
Monetary conditions in the NZ economy are determined by both interest rate and exchange rate levels. Pushing interest rates up now to slow the housing market and reduce inflation risks would only push the NZ dollar even higher and thus reduce incomes and jobs as exporters go out of business.
Monetary policy settings would be excessively tight if this was to happen.
Therefore, the high level of the Kiwi dollar is artificially holding interest rates low in NZ, as RBNZ Governor Wheeler cannot be responsible for pushing the currency even higher still with interest rate increases at this time.
The good Governor perhaps has to be more emphatic in his statements to the markets right now that he will use other macro-prudential tools in his kit-bag on the banks to cool the housing market and will not raise interest rates.
His jawboning down of the currency should categorically state that he will not raise interest rates, so as to scare the currency speculators who have been buying the Kiwi dollar in expectation of higher interest rates as the positive economic news rolls in.
Such a strategy from the Governor will only work if the markets believe his other macro-prudential tools will be effective in controlling inflation by slowing credit growth and thus house price appreciation. Like most things in life, the effectiveness of monetary policy management is largely based around confidence that you will deliver what you threaten to do and that confidence is gained from reputation and credibility.
For the good of the NZ economy (i.e. reverse the NZD movements downwards), the time has come for the RBNZ to put their reputation and credibility on the line by stating that they will implement the macro-prudential measures and they will not raise interest rates.
It would be reckless and pointless for the RBNZ to attempt to intervene directly in the FX markets to bring the NZ dollar down, however they can get smarter with the verbal intervention method.
------------------------------------------------------------------------------------------------
To subscribe to our daily Currency Rate Sheet email, enter your email address here.
No chart with that title exists.
Roger J Kerr is a partner at PwC. He specialises in fixed interest securities and is a commentator on economics and markets. More commentary and useful information on fixed interest investing can be found at rogeradvice.com
2 Comments
Roger,
A surprisingly good article, albeit stating what seems now fairly obvious.
The one bit I'm not convinced of is that intervention would be hopeless. Wheeler has $9 billion to play with, and theoretically a lot more if the Swiss approach was followed. He needs to back any verbals with real action, especially with a Prime Minister deliberately kneecapping him by asking for the currency to go as high as it can.
At the very least we should be printing to pay for new government debt, rather than just feeding the beast with massive own goals by the Treasury. Key won't like that though. He's hoping the house of cards doesn't crash down before next November, apparently.
Yes, I think what you say is true within certain limits. You assume that higher interest rates with result in a higher currency, which seems reasonable. However, I think this breaks down at a sudden and unpredictable point.
As the interest rate goes up then borrowing starts decreasing until we are paying off debt. This creates a pressure for the currency to fall. At some point this downward pressure overcomes the speculative forces pushing the currency up.
The forces at play probably follow a production function not a simple straight line.
We welcome your comments below. If you are not already registered, please register to comment.
Remember we welcome robust, respectful and insightful debate. We don't welcome abusive or defamatory comments and will de-register those repeatedly making such comments. Our current comment policy is here.