KEY POINTS:
Exporters and farmers were quick to applaud Reserve Bank Governor Alan Bollard's intervention in the currency market to drive down the dollar. This was to be expected, given they were the intended beneficiaries of the high-risk manoeuvre. Others were less effusive. They saw, quite accurately, the downside of
what was an ill-judged and largely ineffective move.
Most fundamentally, Dr Bollard has erred by sending out a conflicting message. Just last Thursday, while lifting the official cash rate to 8 per cent, he implied a steelier approach to tackling inflation, notably by taking the wind out of the housing market. Further tightening would, it seemed, follow. Monday's intervention conveyed a totally different impression. Selling the kiwi to lower the exchange rate is an easing move. As such, it is at odds with the thrust of overall monetary policy, and should not have been contemplated at this time.
The contradiction was expressed succinctly in a paper by bank staffers Kelly Eckhold and and Chris Hunt in 2004. "Intervention should be timed to roughly coincide with the broad thrust of interest rate settings," they wrote. "It makes little sense to intervene to try to push the exchange rate lower when the bank believes that higher interest rates may be required in the near future to control inflation pressures. In this situation, a successful intervention would inappropriately loosen monetary conditions."
Dr Bollard has, of course, been under pressure to embrace such a contrarian approach. Perhaps the final straw was the failure of the kiwi to weaken when the American dollar strengthened. It was commonly thought the New Zealand currency was being underpinned by the greenback's softness. The new development seems to have convinced Dr Bollard that another of the bank's criteria - that the kiwi was unjustifiably high - had been met. Even that, however, is debatable, especially given new terms of trade data.
The Reserve Bank's aim is, of course, to minimise the collateral damage of monetary policy to exporters and farmers. He wants to spare them a high exchange rate, while keeping the heat on debt-laden households. That, however, is an unrealistic notion. The simple fact, as Dr Bollard's predecessor, Don Brash, has pointed out, is that, in the long run, the bank can target inflation or the exchange rate, but not both. Even if the bank succeeded in bringing the dollar down, the upshot would be increased inflation pressure and, therefore, higher interest rates. Only reining in the housing market will prompt a sustained fall in the dollar. If that market is not brought to heel, interest rates will have to be raised, again propelling the dollar higher.
Exporters, of course, were cheered by the initial success of the intervention, when US1.4c was shaved off the dollar's value. They would have been less enthused with its subsequent track above 75c, which not long ago was a post-float high and point of minimal relief. All things being equal, that is probably about as good as it will get. The hope that the step will have a significant impact on foreign investors is probably overly optimistic. Commonly, intervention does not disturb a trend for more than a relatively short time.
Dr Bollard's delivery of three rate rises this year, with the likelihood of more to follow, has made dollar-denominated debt more attractive to overseas investors. In such circumstances, trying to orchestrate the selling of the kiwi is tantamount to telling a child he is too young to drive while handing him the keys. It makes no sense, it is risky, and it damages the Reserve Bank's credibility.
