Cullen loath to try to stop rise of dollar

By BRIAN FALLOW, economics editor

The dollar reached seven-year highs yesterday and Finance Minister Michael Cullen refused to rule out intervention in the foreign exchange market, but he emphasised the limitations and risks of options available.

The exchange rate was clearly a huge worry for the economy, he told members of Parliament's finance and expenditure committee.

While the main reason for the appreciation was the weakness of the United States dollar, driven by concerns about its external and fiscal deficits, the fact that the New Zealand dollar had also appreciated against other currencies was a cause for concern, he said.

He stood by his comments in the same forum last year that the Government was "not without options" in the face of currency strength.

But he appeared to be at pains not to raise hopes that his finger was anywhere near the trigger, dwelling on the difficulties and risks attending those options.

"There is an argument that a market perception that we would never intervene may account for some of the differential movement between Australia and New Zealand since there is no such market perception about Australia, since the Reserve Bank of Australia does intervene on occasions," he said.

"But it is pretty clear that you can only knock a bit off the top or bottom of exchange rate cycles."

Given New Zealand's strong economic performance and the US's current account and fiscal deficits, some strong rise in the New Zealand dollar was understandable.

"But I do find it strange given the strength of the Australian economy and upward movement in some of their commodity prices over the last year ...

"It is hard to understand why the market has moved the New Zealand dollar up against the Australian dollar in recent months," Cullen said. "I don't think you should rule out intervention under any circumstances.

"Even the Reserve Bank doesn't, in the case of disorderly markets - although it's in the eye of the beholder what a disorderly market is, it seems to me. But there is only very limited capacity to influence these matters, particularly when the major driver in this case is still the US dollar story."

National's deputy finance spokesman, John Key, asked if he was close to pulling the trigger, since the dollar was close to its all-time highs against the US dollar.

"Not necessarily," he said. "It has been argued by you and by others that while I might have my finger on the trigger there might be a u-turn in the barrel."

He noted that despite serious intervention by the Bank of Japan the yen had still appreciated against the US dollar, although perhaps by 4 or 5 percentage points less than it might otherwise have.

The bigger risk, Cullen said, was the moral hazard.

"If the private sector starts to believe that the Government will intervene regularly in the foreign exchange market then that shifts the risk and the perception of risk away from them having to act on the assumption that we live in an open economy where exchange rate volatility is the norm, as it has been since 1985, and that they can hope that the Government will step in at some point to rescue them," he said.

"I regard that as a more serious concern around intervention.

"On the other hand, in Australia, where intervention has become more common but the RBA hasn't forsworn intervention, the private sector behaves reasonably similarly to New Zealand in the way it tries to manage exchange rate risk."

If the Reserve Bank opposed intervention, the minister has the statutory power to direct it to intervene in the foreign exchange market.

But Cullen said the power was "booby-trapped" by the fact that it might require the suspension of the policy targets agreement between the minister and the central bank. The agreement is fundamental to the transparency of the bank's monetary policy operations.

He sounded unenthusiastic about another option, a decision to boost the Government's foreign exchange reserves target.

Depending on the manner and timing of such a change it could have an effect on the exchange rate at the margins.