Editorial: Overheated dollar can't beat gravity

Opinion

The view of Goldman Sachs, arguably the world's most influential investment bank, that the New Zealand dollar is likely to drop quickly in value next year would have been music to many ears. Among those most heartened by the scenario would have been the country's exporters and the Governor of the Reserve Bank, Alan Bollard. Not that Dr Bollard was ever about to be dissuaded from lifting the official cash rate today. He has laid his cards on the table several times in the past month or so, and will have seen no compelling reason to reshuffle them.

Inflation, with good reason, is the Reserve Bank's core concern. Its most pressing current worry is, therefore, the breaching of the 3 per cent inflation threshold. In October, when Dr Bollard last raised the official cash rate, he made it clear that consumer spending, particularly on housing, was the main obstacle to bringing inflation back within the bank's target range. Further rises in the rate could be ruled out only when this spending moderated, he said.

There has been little to suggest a sudden outbreak of moderation. The housing market remains relatively strong, and retail spending, based on credit-card billings, retains a head of steam. Added to these are the threat to inflation posed by a tight labour market and wage increases, as measured by a 5.5 per cent surge in the unadjusted labour cost index. In sum, there is little to suggest the domestic economy is slowing.

Goldman Sachs' advice to its clients to sell the New Zealand dollar is likely, in time, to reduce the capital available for mortgage lending. The funds of the archetypal Belgian dentist, which have underpinned the housing market bubble, will be transferred to a destination boasting similar interest rates but stronger economic fundamentals.

The investment bank forecasts, in fact, that with the New Zealand economy slowing very quickly and interest rates falling, the dollar could be worth just 63USc in 12 months. In the past few days it has traded around 72USc as the market factored in a rise in the official cash rate. Dr Bollard will, of course, be mindful of the medium-term scenario. In particular, he will be anxious not to cast a pall over business growth intentions. But this is not a situation in which he can afford to exercise patience.

Such is especially the case when eight previous rises in the official cash rate since the start of last year have failed to moderate consumer spending to any great degree. Bank lending practices have ensured that mortgage demand, itself the product of an annual 17 per cent increase in the national median house sale price, has been met. At some point, however, higher interest rates must dampen consumer spending and lead to a fall in the dollar.

Indeed, Dr Bollard's main point of conjecture in the lead-up to today's announcement was probably whether to lift the official cash rate 25 basis points, to 7.25 per cent, or to deliver the jolt of a 50 basis points rise. The finely balanced nature of the economy, and the likelihood that one serious setback could prompt a hard landing, probably ruled out the more dramatic action. But Dr Bollard has every justification to signal that another rise lies in store early next year if consumer demand does not slacken.

Goldman Sachs has cautioned that foreign-investor support for the New Zealand dollar "could rapidly disappear". Today, the Reserve Bank will again tackle the demand side of the equation. How people respond will determine how long gravity continues to be defied - and the degree of pain when everything comes back to earth.