So the Reserve Bank of New Zealand is in a bit of a tight spot. On one hand it wants to raise interest rates in New Zealand and has stated that it will do so aggressively with early increases already underway. On the other hand, it does not want the New Zealand dollar remaining so high and most definitely not going even higher again.
The dilemma here for Governor Graeme Wheeler and pals is that one action that they want to pursue (raising interest rates) creates an undesirable result that they do not want (a rising dollar). The more they raise interest rates, the higher the New Zealand dollar is likely to go.
I have heard a few comments that aggressive rate rises by the Reserve Bank are "fully priced in" yet I don't agree with that.
They can only be priced in to the extent that we do not know what will happen in the United States with potential rate rises from there. Also, they can't possibly be "fully" priced in because we don't "fully" know how high rates will go.
100 basis points? 200 maybe? Which one of those is fully priced in as they are quite different scenarios?
So, what is most important to the Reserve Bank, raising interest rates or a declining dollar?
If they knew themselves then we would most likely know too as their actions would speak for themselves. If a declining dollar was most important to them then they could ease exchange rates with words alone for now - simply announce that further interest rate rises are on hold.
Words can at times be a very effective form of intervention in the currency markets but not when they are weak and open to huge interpretation such as Wheeler's recently that the Reserve Bank could "intervene in the currency market to sell New Zealand dollars". This would need to be followed through with serious action to have any meaningful effect. At the very least, the words would need to become very specific.
Will they really sell New Zealand dollars and risk losing billions swimming against the tide in a currency market much bigger and stronger than the Reserve Bank themselves?
Bigger and wealthier reserve banks have failed miserably with such intervention; the currency markets are just too big and too powerful for selling a few billion to wield any great and lasting magic.
No, the best tool for the Reserve Bank to control exchange rates is to control and restrain interest rate rises. They can do this with nothing other than a statement for now - "rate rises are now on hold".
Then the New Zealand dollar might slow down a bit. If the United States dollar began to rise too then the Kiwi would decline further and exporters will praise the Reserve Bank.
On the other hand, the Reserve Bank might continue its actions of aggressively raising interest rates while using weak words about wanting the New Zealand dollar to decline.
Too bad, it won't. Not unless they get lucky with an event out of their hands and they can sit in hope that a slowing Chinese economy or a major correction in equity markets which might push the NZDUSD exchange rate lower.
New Zealand exporters will not be happy to play that game of 'hoping' another economic event rides to their rescue. In fact, exporters have not been happy for a long time but if the Reserve Bank continues on this path then there is very possibly more misery to come.
Actions must match words and right now the Reserve Bank actions are that rising interest rates are more important than a lower dollar. Maybe that will change in the coming weeks and months; that is what makes this so interesting!
The Reserve Bank would like the best of both worlds but they are unlikely to get it. Their best hope right now is perhaps the commencement of interest rate rises in the United States to offset their own rate rises in New Zealand.
That's possible with the United States economic recovery underway but they are seemingly not there quite yet. Until that time, the next moves from the Reserve Bank will be interesting.
Two weeks ago all advice from New Zealand economists was for the public to lock in a fixed mortgage rate while they still good. That might still turn out to be good advice in the long run but it is not quite as simple or certain as it was a fortnight ago.