Governor marks time on cash rate

By Brian Fallow

Between the lines

Exporters who survived the mid-90s exchange rate ordeal might be forgiven if they are starting to have a sinking feeling of deja-vu.

The dollar is climbing. The Reserve Bank governor is doing his best to talk it down, but the financial markets are sceptical that he would, in fact, cut interest rates for fear of fuelling domestic inflation.

All this at a time when growth is slowing in Australia and Europe, and fingers are crossed that Japan will clamber out of recession this year.

The New Zealand dollar has been tagged a "commodity" currency and rerated in the belief that world growth and therefore commodity prices generally are set to rebound. Trouble is prices for the commodities New Zealand exports, rather than say oil, remain weak.

It looks like a double whammy, poor export prices and a rising exchange rate.

But as Don Brash said yesterday currency movements tend to reflect real economic developments.

In this case the markets may be correctly anticipating a revival in the outlook for New Zealand exporters that the Reserve Bank, and most private sector forecasters, just can't see yet.

That is possible.

Alternatively the markets may have got it wrong, but will react to emerging evidence of that, such as worsening trade data, by selling the kiwi and the exchange rate would retrace some of its recent gains.

On either of those scenarios the bank's wait-and-see policy would be vindicated.

But what if the currency continued to appreciate in the face of mounting evidence that the export sector was being hammered?

In that case, if there was a risk that an imploding export sector threatened deflation, Dr Brash would of course be compelled to cut interest rates.

But that is a fairly remote possibility.

It has to be remembered that the present monetary environment represents uncharted waters for New Zealand.

No-one can be sure how people will react to a prolonged period of low and stable interest rates.

Building consents in April were down on March but stronger than any other month since September 1997.

The nightmare scenario of a return to the combination of a struggling export sector and a hyperactive housing market driving the inflation rate higher cannot be ruled out.

But that danger at this stage is remote.

It is more likely that either commodity prices will revive to support the currency rise or the appreciation will falter.

Deutsche Bank's economists favour the former view. They expect the kiwi after a brief downard correction to resume its upward trend, based on evidence of stronger world growth and a broadening recovery in commodity prices.

Bankers Trust expects it to hit 59USc by the end of the year.