The high NZ dollar: the trickiness of any currency intervention

The high-running New Zealand dollar plus the political “noise” around the looming election is likely to put more pressure on the Reserve Bank to “do something” about the currency.

Over the past week the New Zealand dollar headed above 87USc toward a previous peak of slightly more than 88USc and some currency analysts are picking it could hit a record 90USc.

Questions of intervention of some sort are being raised: the fact deputy Reserve Bank governor Geoff Bascand is delivering a speech on currency matters tomorrow has heightened interest although any comment on actual intervention is more likely to come from governor Graeme Wheeler.

The Reserve Bank has four formal criteria for currency intervention.

• The currency has to be at an “exceptional” level;
• That level has to be not justified
;
• Any intervention by the Reserve Bank has to be “consistent with monetary policy (that is, not inflationary); and
• There have to be market conditions which would make such an intervention successful,

In practical terms, these four can be boiled down to two: any intervention has to actually stand a chance of working, and to not lose money – and it is possible to lose a lot of money in currency interventions, even for rich countries. 

The Swiss monetary authorities lost the equivalent of around $NZ20 billion trying (unsuccessfully) to influence their currency in a different direction to where investors were taking it.

The Reserve Bank has only, at current levels, a little more than $NZ8 billion for currency intervention.
The world currency trade is between $US4-5 trillion  a day: the New Zealand dollar is the 10th most traded currency in the world with daily turnover of, typically, $US25-30 billion.

In that environment – as the Reserve Bank has outlined, many many times – it can only “attempt to smooth the peaks of the USD/NZD exchange rate; we cannot determine the level,” as Mr Wheeler said in a speech on the issue last year.

Of the four formal criteria, the first two are definitely present (exceptional currency levels; the level is not justified).

The third, it should not add to inflation, is more problematic. Inflationary pressures are growing, and they are driven by domestic factors. A downward shift in the exchange rate would mean higher prices for imports and would kick up the internal costs overall – particularly fuel and petrol.

The fourth, “market conditions which would made an intervention successful” is close to tautalogous.

What it means in practice is the currency should be about to change direction anyway and the Reserve Bank’s intervention would only shave a bit off the peak, or perhaps nudge a fall (or a rise, at the bottom of the cycle) a little sooner than might otherwise have happened.

A fall in the currency is seen as likely by the end of the year – the question is when. The most likely domestic trigger is a signal from Mr Wheeler he is not going to hike the official cash rate (OCR) as steeply as he previously signalled.

The next review is on July 24: economists and financial markets expect a further rate hike.

However, the overnight index swap (OIS) markets are now pricing in fewer hikes between now and the end of the year: implicit in current trading is hikes to around 3.75% by December, instead of the 4% previously anticipated  (and still implied by the Reserve Bank’s own official outlook).

A sudden formal change in outlook by the Reserve Bank could see the currency fall – although the fact the markets are already pricing such a shift in indicates that impact may not be so dramatic.

A more likely “shove” should come from any change by overseas monetary authorities: particularly the US Federal Reserve or the Bank of Japan.

Both are under pressure to pull back from their aggressive “quantitative easing” (or money printing) programmes of recent years. The US has already begun “tapering” its money printing operation: the Bank of Japan’s more recent opening of the monetary sluices could ease off as that country’s economy improves.

The Bank for International Settlements – the “central bankers’ bank” last weekend called on monetary authorities to move back more determinedly to less unconventional settings, and made the point the longer they delay, the more bigger risk there is to the world economy.

For New Zealand, we can add to this more “real economy” factors. GDP is expected to nudge 4% for the current year but that is most likely to be a peak due to high terms of trade now coming off as the milk price falls.

In other words, the New Zealand dollar is very definitely over-valued. The only question is when, and how, it will correct.

The Reserve Bank might intervene but only when it thinks the exchange rate is about to change direction anyway, and it can get ahead of the market – and make a few million dollars in the process.