Dollar poses dilemma for Bollard

Alan Bollard. Photo / Mark Mitchell

Reserve Bank governor Alan Bollard left the official cash rate on hold at 2.5 per cent yesterday, as expected, and the accompanying statement was unequivocally dovish.

The economy remained weak, he said, the outlook was uncertain, the recovery when it came later this year would be patchy and any return to healthy rates of growth was some time away.

Bollard stressed the exchange rate was not helping the sustainability of future growth and said that if the easing in monetary conditions the bank had forecast in June did not eventuate "we would reassess policy settings".

This had the immediate desired effect. The dollar fell more than half a cent against the US and Australian dollars and the euro. It closed at US64.95c yesterday, down from US65.85c on Wednesday.

The dovish tone was later reinforced by the release of weak credit growth numbers for June, showing mortgage lending only 2.8 per cent up on a year ago and business lending 3.4 per cent higher.

But ANZ National Bank economist Philip Borkin pointed to the unresolved dilemma lurking behind the Reserve Bank's statement.

It was all very well to try to talk the dollar lower by threatening to cut the OCR again but "jawboning must ultimately be matched by action and such action risks stoking the housing market further".

Though there was nothing said about it yesterday, the bank has been fretting about the risk of a return to the unbalanced growth of the past, led by the housing sector - which has been showing signs of life - but accompanied by an exchange rate that hobbles the export sector.

"We are in little doubt the end game here is ultimately a greater use of prudential policy [the bank's powers as banking regulator] as a means of assisting the relatively blunt instrument of the OCR," Borkin said.

But ASB chief economist Nick Tuffley took the absence of any mention of green shoots or upside risks from net migration and housing as a clear message that an unsustainable recovery was not the bank's primary concern and that the weakness of the export sector was a far greater risk.

Westpac chief economist Brendan O'Donovan questioned whether the stronger currency was a threat to the recovery. "Often currencies are actually telling us something about the fundamentals, and it's not obvious that they've been wrong to date," he said.

"If the market is overestimating the strength of the recovery, then the New Zealand dollar is likely to fall of its own accord, and if the market is correctly anticipating the recovery, then a stronger dollar won't be enough to cancel it out."