Right inflation signals needed before rates can be cut says Bollard

By BRIAN FALLOW economics editor

Reserve Bank Governor Alan Bollard yesterday acknowledged the concerns of exporters over the strength of the New Zealand dollar.

The bank would never be complacent about exchange rate swings, but was limited in what it could do to prevent or moderate them, he said in a speech to the Canterbury Employers Chamber of Commerce.

It could, however, offset the dampening effect of a higher dollar on economic activity.

"We will have to look closely at the data over the next few months for evidence that points to reduced pressure on resources and medium-term inflation.

"If that evidence emerges and if the exchange rate remains at around current levels, or even rises further, there may be scope for a cut in the official cash rate later in the year," he said.

Deutsche Bank chief economist Ulf Schoefisch said that by adding the phrase "next few months" to his comments from Thursday there was the suggestion that Dr Bollard did not expect to have sufficient evidence for an easing in early March.

"Dr Bollard supported that conclusion in the Q&A session when he said that March was too early to know the impact of the strong New Zealand dollar."

Bollard said that the past year had seen one of the largest swings in the exchange rate since it floated 18 years ago, but it had started from levels too low to be sustained.

"Even after a striking 30 per cent rise against the US dollar that exchange rate is still only now around its average level for the past 10 years. On a trade-weighted basis the exchange rate is now only a few per cent above its long-term average."

The low dollar had been a mixed blessing, good for producers, bad for consumers. "It tends to feel better in the countryside than in the cities. It makes our wages look less attractive to prospective skilled migrants, but our beachside houses also appear cheaper to those wealthy foreigners looking for an Antipodean holiday home."

So are high interest rates what has attracted international money into New Zealand, forcing up the exchange rate?

Bollard said rates were low by New Zealand historical standards, lower than they were when the exchange rate was falling and only lower than this three times in the past 20 years.

Nor is an interest rate differential anything new. "New Zealanders' appetite for debt has meant we have long had interest rates that have been somewhat above those of most developed countries."

While the Reserve Bank influenced short-term interest rates over short periods, "the average or normal level of interest rates over periods of years is mainly determined by New Zealanders' willingness to save and appetite to borrow".

In the short term, changes in exchange rates tended to reflect investors' changing views.

"Those perceptions and attitudes can be well founded or out of line with reality for a number of years. At times they can shift quickly," Bollard said.

For several years investors globally were taking a gigantic punt on the United States, the leader of the "new economy".

"Even with our official cash rate at 6.5 per cent through much of 2000, investors just weren't that interested in New Zealand. High-tech equity markets were where the good returns were expected."

And despite Australia's stellar economic growth in the 1990s, markets were just as uninterested in that country. Both Tasman currencies fell further than most.

But while the New Zealand dollar had since returned to more normal levels on average - the US having fallen out of favour - the Australian dollar had not, with the result that against our transtasman neighbour our exchange rate was not far off record highs.

"First, we've had higher interest rates than Australia (and the gap has increased somewhat) in a period when secure fixed income returns have been particularly attractive," Bollard said.

"Second, validly or otherwise, markets have taken the view that the New Zealand economy is growing more robustly than Australia's at present - the drought, fires, and all that.

"And third, when both the New Zealand and Australian dollars are rising or falling, our currency has often gone a little further than theirs, perhaps something to do with our smaller size and less liquid markets."

He noted that in a recent global survey of financial market commentators the Australian dollar was identified as the currency likely to rise most this year.