By JIM EAGLES business editor
If Reserve Bank policy was still governed by the monetary conditions index the extraordinary flight of the kiwi would see bank Governor Alan Bollard announce a 4 percentage point cut in interest rates on Thursday.
Under the McI regime, a 2 per cent movement in the dollar's trade weighted index (TWI) automatically produced an interest rate movement in the opposite direction of 100 basis points (or 1 per cent).
Since November, when Bollard described monetary conditions as absolutely neutral, the TWI has climbed from 56.25 to 60.77, an increase of 8 per cent.
In other words, other things being equal - and not much else has changed since November - a few years ago the latest rise in the dollar would have seen the official cash rate cut from 5.75 per cent to 1.75 per cent.
Of course Bollard will do no such thing. The Reserve Bank has abandoned the MCI policy.
A poll of 13 economists by Bloomberg News at the weekend produced a unanimous prediction that there would be no change in the official cash rate.
But the relentless climb of the kiwi has moved sentiment from a general assumption that Bollard will maintain his determinedly neutral stance to an expectation that his statement might well hint at an easing later in the year.
The Bloomberg poll notwithstanding, there are even a few economists starting to wonder if Thursday might bring an unexpected 25-point cut.
The MCI calculation serves to underline why that view is growing.
"Sure, the MCI link has been dropped, but the concept still remains valid," said Deutsche Bank senior economist Darren Gibbs.
"You can't have the currency go up this much and leave things unchanged."
On balance, Gibbs still believes the most likely outcome is that interest rates will stay unchanged until the middle of the year.
"But," he said, "we could get a surprise on Thursday. The Governor might take the view that given the new flexible Policy Targets Agreement [between himself and the Minister of Finance] a reasonable monetary policy stance in the present circumstances would be lower interest rates."
The extent of the kiwi's climb has certainly caught most people, including the Reserve Bank, by surprise.
It is already more than 7 per cent ahead of the track forecast by the bank in November. On Friday, the kiwi had its biggest day in six months, closing at new highs against both the Australian and US currencies, 54.70USc and 92.90Ac, respectively.
But it did not stop there. Over the weekend disappointing economic data and fears of war against Iraq led the US dollar to slide further against most currencies.
The kiwi shot to 55.35USc, and the Australian dollar hit 59.19USc, both of them levels not seen in nearly four years.
Perhaps more surprisingly, enthusiasm about New Zealand's good economic performance in the second half of last year helped the kiwi gain on the resurgent aussie, reaching 93.30Ac, the highest level since July 1995.
Yesterday, the kiwi basically held those levels, closing at 55.05USc and 93.30Ac.
The impact of the rise is clearly visible in the ANZ Commodity Price Index released today (see story above).
The index shows that world prices for New Zealand's main exports rose 0.4 per cent in December.
That was more than offset by the rise in the kiwi in December when the index fell 2.1 per cent in New Zealand dollar terms.
But if the index had been calculated in terms of the kiwi's value as at noon yesterday the index would have fallen 5.9 per cent.
That, said ANZ's chief economist David Drage, "is a clear indication of how much potential damage a higher currency can wreak on the export sector".
Drage said it was important to emphasise that the effects were "potential" because many exporters had long-term price contracts and others had currency hedges so reduced returns for exporters would take some time to work through the economy.
Similarly, because the economy was so strong, importers might be able to take advantage of lower prices for imports to rebuild their margins rather than pass them on immediately to consumers. But the impact would come eventually.
How high can the kiwi go? One indicator may be the Big Mac Index produced by the Economist magazine.
The latest index, released at the weekend, shows that a Big Mac costs US$2.65 in the United States, US$2.12 in New Zealand and US$1.76 in Australia (at exchange rates on January 15).
That implies that the kiwi is still about 20 per cent undervalued compared with the US dollar and so could have some way to go. But it also indicates the kiwi is 17 per cent overvalued compared with the aussie and so could be heading for a correction.
The kiwi's gravity-defying efforts mean no one is quite sure how high it will fly.
"I guess we're expecting a pullback," said Gibbs. "But then we expected that one or two cents ago and it didn't happen."
In the meantime Finance Minister Michael Cullen must be starting to feel nervous about the impact on the economy. Late last year he commented that while 50USc was probably acceptable 89.5Ac was not. Cullen's office said yesterday that he would not comment on the much higher levels now reached.
National finance spokesman Don Brash pointed out that at 60.77 the TWI was now "just about exactly where it was after devaluation in July 1984" and "probably about the average since it was floated".
Dollar's rise nudges bank rate neutrality
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