Reserve Bank talking tough on exchange rate

Photo / Mark Mitchell

Governor reminds forex market that previous corrections have been steep.

The New Zealand dollar could fall significantly over the next six to nine months and the Reserve Bank would welcome that, says Governor Graeme Wheeler.

In an unusual move, Wheeler released a long and unheralded statement elaborating on the bank's view that the currency is unjustifiably and unsustainably high and pointedly reminding the forex market that previous corrections have been steep - averaging a 28 per cent fall, peak to trough, including 10 to 12 per cent in the first year.

The bank's move fuelled speculation about whether it has already put its money where its mouth is and intervened in the market or, if not, whether it is about to.

The bank is scheduled to publish on Monday the level of its foreign currency holdings at the end of August, which would show if it had intervened to nudge the New Zealand dollar lower last month.

"This reads like a pre-emptive explanation of whatever may come out of those figures," said Westpac economist Michael Gordon.

"In any case they clearly haven't been appeased by the fall in the currency to date."

Wheeler said the exchange rate had not adjusted "materially" to the downward movement in commodity prices, including a 45 per cent fall in export dairy prices since February.

ANZ senior currency strategist Sam Tuck said it was very unusual for the Reserve Bank to issue a statement like this.

"Which I guess means their focus has clearly changed and they think the currency needs to be a lot lower. They are likely to be backing this up with action, rather than just words," Tuck said.

But tactically if the bank wants the dollar to fall it might want market participants not to be sure if a new player with an unlimited supply of New Zealand dollars is selling.

"I would expect uncertainty about whether they are or are not in the market would play into their hands," Tuck said.

"I think it means don't expect the [US]80c level to support the kiwi too much more, whereas before a lot of people have been talking about a bit of a pause around this level and a bit of support. I think they are giving us a reason for it to go further."

The NZ dollar fell as low as US79.91c yesterday, and was trading at US79.94c at 5pm, compared with US80.73c at 8am and US80.80c on Wednesday.

The bank has been describing the New Zealand dollar's level as unjustified and unsustainable - two of the criteria of its mandate to intervene - since July.

Yesterday Wheeler said the real exchange rate was "well above" its sustainable levels and also above levels justified by short-term business cycle factors.

"Unsustainable" in the bank's lexicon means it has clearly deviated from an equilibrium level consistent with balance in the country's external accounts over the long term, given certain assumptions about the terms of trade, domestic and world growth rates, interest rates and external debt levels.

In addition the kiwi remains "unjustifiably" high inasmuch as a fall of 3 per cent in real trade-weighted terms since July is too small given recent falls in commodity prices, the factor that best explains movements in the real exchange rate.

"Unjustified and unsustainable are important considerations in assessing whether exchange rate intervention is feasible," Wheeler said.