Kiwi falls after Brash questions recent rise

By Brian Fallow

WELLINGTON - The New Zealand dollar fell yesterday after Reserve Bank governor Don Brash said he was puzzled by its recent rise and it was not yet clear that it was justified.

"If the recent firming of [monetary] conditions proves to be persistent, and not well justified by the emerging data, the bank may have to look at reducing the official cash rate in the future," Dr Brash said when releasing the bank's latest quarterly monetary policy statement.

Market economists, however, think the chances of an interest rate cut are very low; they remain divided on whether Dr Brash will raise rates before Christmas or early next year.

The dollar had risen about 6 per cent since the previous monetary policy statement in March, a rise market commentators attributed partly to Contact Energy-related buying, but primarily to international investor interest in the "commodity currencies" in anticipation of stronger world growth and a revival in commodity prices.

The Reserve Bank however expects commodity prices to remain weak for some time and economic growth among New Zealand's trading partners overall to recover only gradually from low levels and not to pre-Asian crisis levels.

Drought and the continuation of La Nina weather are expected to keep farm exports weak for some time, and cause the trade balance to deteriorate next year.

"We don't see any logic in the numbers for the very strong rise [in the exchange rate] in the last little while," Dr Brash said.

The dollar dropped more than half a cent after his comments, and ended yesterday around $US55.2c, a full cent below Tuesday's close.

Analysts said yesterday that either evidence would emerge which justified the dollar's recent rise - stronger world growth and a pick-up in New Zealand's commodity export prices - or it would not, in which case the currency should retrace some of its recent gains.

Only if the appreciation proved both persistent and unsupported would the bank face the dilemma of whether to make a compensating cut in interest rates and risk fuelling domestic inflation.

"We believe this is unlikely," ANZ Bank chief economist Bernard Hodgetts said. "More generally of course continued strength in the currency would tend to stave off the point at which the bank moves to raise the official cash rate."

National Bank chief economist Brendan O'Donovan said Dr Brash would be reluctant to cut interest rates when borrowing demand was growing strongly, house prices starting to rebound and retail sales were strong.

As almost universally expected, Dr Brash left the official cash rate unchanged at 4.5 per cent. The bank's forecasts are little changed from three months ago, with domestic-led economic growth proceeding at a pace of about 0.7 or 0.8 per cent a quarter, which poses little inflationary danger. It sees stimulatory monetary policy as appropriate for "some quarters ahead".

Since the last MPS some, councils have proposed large rates increases, retail electricity prices have risen and crude oil prices too. But the bank does not expect these one-off rises to flow through to generalised inflation. It sees the consumers price index excluding interest (CPIX) spiking up to 1.9 per cent in the first half of next year, but then subsiding to around the mid-point of the bank's 0 to 3 per cent target range.

Deutsche Bank chief economist Ulf Schoefisch believes increasing underlying inflation pressures will keep inflation around the 2 per cent level. He thinks wage growth will be higher and productivity growth lower than the Reserve Bank projects and that it is still overestimating the amount of spare capacity in the economy.