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There is little the Reserve Bank can do to bring the New Zealand exchange rate down, governor Graeme Wheeler says.
This afternoon Mr Wheeler told Auckland manufacturers intervention in the currency is difficult and only likely to be successful under certain circumstances.
He also says lowering the official cash rate – as some business groups have urged – would not necessarily have any impact on the currency. The kiwi dropped half a US cent after release of the speech.
“Since late 2010 the Reserve Bank of Australia has cut its official cash rate by 1.75% to its current level of 3% without significant impact on the Australian dollar.
“The yen appreciated by over 30 between February 2007 and November 2012, a period where the target rate was lowered from 0.5% to a range of 0.1% to 0%. The Swiss franc appreciated by about 20% between January 2010 and July 2011; despite the central banks target interest rate range between zero and 0.75%.
Intervention is possible but is likely to produce only short-term relief, he says.
The Reserve Bank has four criteria for effective intervention: the rate has to be at an exceptional level; the level has to be not justified; any intervention has to be consistent with monetary policy (i.e., not inflationary) and there have to be market conditions which would make such an intervention successful.
“The last factor is particularly important. Globally, exchange rate turnover is in the range of $US4 trillion to $US5 trillion a day.
"Band of International Settlements surveys suggest the Kiwi is about the tenth most traded currency in the world with daily turnover of spot and forward transactions totalling around $US27 billion in April 2010 (the latest BIS survey).
“The Reserve Bank is prepared to intervene to influence the Kiwi. But given the strength of recent capital flows, we can only attempt to smooth the peaks of the USD/NZD exchange rate; we cannot determine the level.
“When the NZ dollar is coming under upward pressure, we want investors to know that the Kiwi is not a one way bet.”
That leaves the fashionable policy nostrum of quantitative easing or printing money.
That has been used by countries with interest rates at almost zero yet still faced by households and firms unwilling to expand and holding high debt levels they wished to reduce.
“Quantitative easing aims to stimulate wealth effects in the economy by increasing liquid balances and generating higher prices for equities and financial and real assets. It’s also designed to raise bank profitability as a means of strengthening banks’ capital positions.
“And it was hoped that higher bank capital, through retained income and capital injections, would lead to additional bank lending to corporates, and especially credit constrained small and medium sized enterprises and households – at a time when many were reducing their leverage.”
It is not clear this has actually worked, he says.
“The intention was to encourage borrowing and investment by entrepreneurs, businesses and individuals, not financial intermediaries. On this, the evidence has been flimsy at best.”
In any case New Zealand is not in the position of countries, which have adopted quantitative easing.
“New Zealand did not experience this type of economic damage and quantitative easing, together with its precursor of very low interest rates, is not justified in the New Zealand situation.
"Our economic challenges are different from the US, Euro area, and Japan, and quantitative easing would increase inflation, raise inflation expectations, stimulate asset prices, and lead eventually to higher interest rates.”
A further idea gaining traction is emulating the Swiss example and “capping” the exchange rate at a certain level by purchasing foreign exchange in what amounted to unlimited quantitates so as to hold the currency at a certain level.
That would be “risky” for New Zealand, Mr Wheeler says.
Firstly, the Reserve Bank’s official cash rate (OCR) – currently at 2.5% – would need to drop to zero, so as to stop currency traders taking advantage of the interest rate arbitrage.
“Any attempt to retain non-zero interest rates by 'sterilising' such massive intervention would be very difficult. In effect therefore, a Swiss type operation to cap the value of the NZ dollar through large scale FX intervention would also amount to quantitative easing.
“As I mentioned, this would be highly inflationary in the NZ context.”