It has become almost a creed in this country that the Reserve Bank is powerless in the face of international capital flows. However, given the peculiar nature of the latest pressures, it would be a brave call to dismiss the bank's arsenal out of hand.

If push comes to shove the bank could put in place the sort of "quantitative easing" measures that are now being rolled out by authorities such as the US Federal Reserve and the Bank of England.

Two recent developments have reinforced the received wisdom about New Zealand's central bank - the surge in the dollar and the surge in swap rates (effectively New Zealand wholesale funding rates).

Rising swap rates amount to an increase in long-term funding costs and ultimately lower profit margins for local businesses. This is particularly evident in longer-term rates, which put in an alarming rally of more than 100 basis points in March. Reserve Bank Governor Alan Bollard said the surge was "unwarranted and inconsistent with the monetary policy outlook."

The recent surge of the dollar meanwhile threatens to put the brakes on significant cause for hope about the local economy - the possibility of an export-led recovery.

The benign analysis of swap rates is that the New Zealand economy is showing signs of reaching a trough and that markets are anticipating a time when more normal economic conditions prevail and the Reserve Bank is forced to tighten monetary conditions to prevent the economy over-heating.

The pessimist would regard the rising swap rates as evidence that New Zealand, in the wake of the financial turmoil, is finding it hard to raise debt. In short, rising rates are evidence of international investors demanding extra compensation for extending credit to New Zealand.

The rise in the dollar may be related.

A pessimist also would say the rise in the New Zealand risk premium (read higher interest rates) may have been sufficient to re-ignite the carry-trade. This is the trade where hedge funds borrow in a low yielding currency such as Japan or the US and then invest the proceeds in New Zealand at a much higher rate and pocket the margin. Such a trade is associated with the demand for the kiwi dollar and its strength.

The optimist would, alternatively, declare international investors believe the worst of the economic turmoil is behind them and that they wish to take on more risk. The rising dollar is evidence that investors are eschewing safe haven assets such as US treasuries and favour assets such as emerging markets. Such a switch will be associated with US dollar weakness and more to the point New Zealand dollar strength.

Between these polarities there are many interpretations.

Bollard, however, has made it crystal clear that international markets are thwarting his ambitions. His statement decrying the rise in swap rates is a clear indication that he does not sit on the side of the optimists and that he still sees significant headwinds for the economy if a lower dollar and lower interest rates are not allowed to do their job.

More to the point, he is making a barely veiled and very tangible threat.

The conventional policy response to such rising wholesale rates is to cut the official cash rate. Unlike the central banks offshore Bollard still has plenty of ammunition for this weapon. Indeed, with the cash rate still at 3%, Dr Bollard still in theory at least has the potential to cut as much as 275 basis points from official interest rates. This is almost as much as the Federal Reserve lopped from the Federal Funds Rate throughout 2008.

Cuts should weigh on short-term rates and if deep enough would eventually begin to weigh on the longer rates as well as international markets impute interest rates remaining lower for a longer period of time.

But if, in the wake of worsening credit market turmoil, international investors refused to pass on the margin between official and wholesale rates, quantitative easing could be rolled out.

In the US and elsewhere central banks have implemented the policy by buying government debt, financed by money produced by the printing press (more accurately the central bank creating cash deposits in trading banks' clearing accounts).

In New Zealand the bank could do the same by buying up debt issued by government, the major trading banks or even, more radically, start lending to the wider business community directly. The central bank's mere consideration of such moves would have a profound effect on swap rates as it would open up, theoretically at least, a limitless supply of New Zealand dollar funding. Yields would fall as the central bank crowded out other lenders. Such a move would also erode the foundations of the carry trade.

Although such measures would set off fears about inflation (potentially sparking a rally in long-term interest rates), they are only likely to be implemented in the midst of a sharp contraction where the threat of deflation was much more real.

The dollar might flounder. Apart from a reduction in the carry trade, lenders might worry about the country's credit worthiness. But a weaker dollar is a necessary condition for an export led recovery.

The immense flexibility of the New Zealand economy and the central bank to deal with these pressures is one of the key reasons locally based investors should feel confident about the prospects for the New Zealand economy and the share market.