Bank intervention a shock

Reserve Bank Governor Graeme Wheeler. Photo / Mark Mitchell

Governor’s announcement on inflation caught many in trading rooms by surprise but had the desired effect of knocking kiwi down a peg

Reserve Bank governor Graeme Wheeler may as well have lobbed a hand grenade into the country's foreign exchange dealing rooms this week when he let loose with a strident and unexpected missive about the state of the dollar.

Wheeler said the bank considered the level of the exchange rate to be "unjustified and unsustainable" and that it is "susceptible to a significant downward adjustment".

It was a familiar theme; he's used similar language before.

But the announcement - a one-page media release with seven pages of commentary, graphs and details - was unexpected as the Reserve Bank's important communications are almost always through scheduled events, such as official cash rate reviews.

Paul Bloxham, HSBC's chief economist for Australia and New Zealand, said Wheeler's comments caught the market by surprise.

"As far as central bank commentary goes, it was an exciting way to do it," he said.

The governor may have left many dazed and confused by his actions, but he certainly achieved what many called "bang for his buck" in terms of talking the currency down.

In the next 24 hours the currency dropped by US1.6c and by 5pm yesterday the kiwi had ducked below US79c.

At one point, the Australian dollar was caught up in the selling, dropping by about 35 pips to US87.74c - its lowest point since early February.

Wheeler's comments went strongly on the theme that the currency was not reflecting the sharp decline in commodity prices - dairy in particular - as it should.

He hinted that Reserve Bank had, or was about to, intervene in the foreign exchange markets to bring down the value of the currency further.

Central bank intervention is not for the faint-hearted.

Experts have likened it to standing in the way of a speeding train; one central bank pitted against the raw power of a multi-trillion-dollar currency market.

In the Reserve Bank's case, the key barrier for a weaker kiwi, until quite recently, has been a weak US dollar.

Any attempt to engineer a lower kiwi was always going to fail when the US dollar was weak. But now that the US dollar is starting to reassert itself, the bank has a freer hand to intervene and is more likely to succeed.

"It was certainly well timed and the kiwi fell through key support levels without much resistance," said ANZ senior foreign exchange strategist Sam Tuck.

The action was timed to reinforce an already weakening trend, he said.

"They got it right, definitely. It was a masterclass in verbal intervention," Tuck said.

Reserve Bank data for August, due out on Monday, will show for sure whether the Reserve Bank was in fact in the market selling kiwi in August, as many suspect.

For the moment, the Reserve Bank has been successful in lowering the currency, but HSBC's Bloxham said the Reserve Bank should be careful about what it wishes for. "A low currency will bring inflation with it," he said.

"The economy is still growing at pace, which means those inflationary pressures will build over the coming quarters, so my sense is that the strong currency is still consistent with the New Zealand economy, which is outperforming the economies of the Western world," he said.

Outside the foreign exchange market, the weaker dollar is likely to make its presence felt, for New Zealand companies and for global investors with holdings in New Zealand.

Shane Solly, portfolio manager at Harbour Asset Management, said ongoing weakness in the currency would help New Zealand businesses such as Fisher and Paykel Healthcare, whose sales are mostly in US dollars.

On the flipside, the importing companies, including many in the retail sector, would stand to lose out.