KEY POINTS:
If Reserve Bank Governor Alan Bollard fails to increase interest rates again next week, questions about the bank's independence from the Beehive look inevitable.
Dr Bollard is due to review interest rates on Thursday and most economists predict he will push them up for the fourth time this year as he battles persistent inflation.
But new spice was added to the equation this week when Finance Minister Michael Cullen openly discussed a little-known section of the Reserve Bank Act which allows the Government to intervene and prevent rate rises. His move is widely seen as an attempt to talk down the dollar, which hit another post-float high of US79.50c yesterday.
However, his comments have also been read by some as an attempt to lean on Dr Bollard to prevent another interest rate rise - something Dr Cullen denies he is doing.
ANZ chief economist Cameron Bagrie yesterday said there was a lot of pressure on Dr Bollard, and if he did not raise rates next week questions would be asked about the bank's independence.
Westpac chief economist Brendan O'Donovan agreed Dr Bollard was under pressure, and said the type of behaviour displayed by Dr Cullen was "never helpful".
"Cullen has explicitly said that it's not directed at Dr Bollard, but it does create that risk that when the market pricing is there for a hike, if he doesn't go the perception will be that it's because of the political interference," he said.
The Reserve Bank operates independently from the Government, meaning that it can raise or lower interest rates whenever it wants without being influenced by politicians.
Backers of that structure argue that if that independence was not present, monetary policy would be subject to the vagaries of politics.
Q & A
What did Finance Minister Michael Cullen mean when he said this week that the Government could step into the Reserve Bank's interest rate decisions?
Dr Cullen drew attention to the fact that the Government can, under the Reserve Bank Act, tell the bank to base its interest rate decisions on factors other than inflation. For example instance, he could tell the bank to base its decisions on the soaring New Zealand dollar. If the Government moved, it would mean effectively suspending for up to 12 months the agreement the Beehive has with the bank to target inflation.
What would the likely effect of that be?
If the Government told the bank to focus on the exchange rate and pay less attention to inflation, for instance, it is far less likely the Reserve Bank would raise rates. In fact it could actually cut them. That would likely bring down the New Zealand dollar and provide relief for the chunk of exporters who are suffering from the currency's levels. Homeowners would also likely benefit from lower mortgage rates.
That feels great, so why not do it?
There are risks - and big ones. Firstly, it would mean that higher inflation would be tolerated. Some New Zealanders may have forgotten the negative impacts of higher inflation. As ANZ Bank chief economist Cameron Bagrie puts it, everyday living costs rise - we actually end up paying more for groceries, energy and housing. In terms of everyday living, the cost of inflation far outweighs the near-term cost of a hike in interest rates.
There is also the risk to New Zealand's reputation as a country with a stable monetary policy framework and solid economic management. The appetite among New Zealanders for debt outweighs our willingness to save, and that means money is brought into the country from overseas. The people who are lending that money to us could attach a higher 'risk premium' to it if New Zealand looks less stable. Our interest rates are likely to actually rise in the long-term.
So what was Dr Cullen up to?
While he won't rule out entering the fray, it is more likely Dr Cullen was simply trying to unnerve the so-called speculators who have been pushing up the New Zealand dollar. The currency is enjoying a strong run against a weak US dollar and has been supported by rising interest rates.
What will Reserve Bank Governor Alan Bollard do?
Dr Bollard will announce his next interest rates decision on Thursday, and it is expected he will again raise rates, possibly pushing the dollar up even further. Inflation remains a concern for him, and his job is to keep inflation under control.
What might happen politically?
Dr Cullen will continue to come under political pressure from his rivals. National is claiming the Finance Minister's credibility is shot, while New Zealand First is urging him to take action. There is a risk that the whole situation could end up damaging Labour. Dr Cullen will no doubt mount a strong defence of his economic management and point out that he can't control a weak US dollar.
Japanese housewife's interest in kiwi
So who is Mrs Watanabe, the Japanese housewife being partly blamed for the dollar's rise?
Finance Minister Michael Cullen mentioned her in Parliament this week. Mrs Watanabe is, of course, a made-up character. She is a stereotype of the typical investor who is putting money into New Zealand because of our relatively high interest rates.
The math is simple: Japan's cash rate is 0.5 per cent, and ours 8 per cent.
If Mrs Watanabe invests her money in New Zealand bonds, she gets a much higher interest rate than she does if she invests her money in Japan.
The New Zealand dollar-denominated bonds, known as uridashis, are available to investors in Japan. Savers, mostly housewives, there have been buying them for years.
Mrs Watanabe may not actually choose the investment but simply put her savings into a bank.
