KEY POINTS:
The dollar is edging up again, in the wake of the Reserve Bank's intervention yesterday which attempted to drive down the currency.
The New Zealand dollar was trading at around 76.20 US cents yesterday morning and dropped by around a 1.5 cents before starting to stage a recovery last night. After starting today just under 75 US cents, it is now trading at at 75.13.
Analysts are divided on whether the intervention it will work long term. Steve Barrow of investment bank Bear Stearns says New Zealand's interest rates are too attractive and the Reserve Bank will struggle to turn around the strength the dollar has shown in the past few years.
"Any central bank that tries to take on the currency market right now is going to find that it is struggling against a weak US dollar, and that's going to make it particularly hard."
Shock and awe
In a high-risk move, Reserve Bank Governor Alan Bollard has ambushed the money market by intervening to drive the New Zealand dollar lower.
If the aim was shock and awe, it succeeded. The dollar, which at 8am yesterday was trading at US76.19, dropped more than a cent. By 8.30 last night it recovered to US75.1c. Overall the bank's move pushed the currency down 2 per cent.
It is the first time the bank has intervened since the currency was floated in 1985.
Economists were flabbergasted, because they thought at least some of the conditions the bank had said would have to apply before it intervened were not satisfied.
In particular, the move came hard on the heels of Dr Bollard raising his official cash rate last Thursday - the third interest rate rise in as many months. That is supposed to curb inflation, but a lower dollar will tend to push up prices.
"It's a hell of a shock," said Westpac chief economist Brendan O'Donovan.
Dr Bollard said the exchange rate was unjustified in terms of the economic fundamentals. That is one of the boxes that has to be ticked before the bank intervenes.
But Mr O'Donovan said it was "hugely questionable" whether the markets would see it that way, when New Zealand had the highest interest rates in the developed world and commodity prices, particularly for dairy products, were at an all-time high.
Mr O'Donovan said the market would have the last word. "If it doesn't think the currency was unjustifiably high, it will take the bank on. Their success may be relatively short-lived."
Only last week the bank had said the way to get the exchange rate sustainably lower was to get on top of domestic inflation.
"Dr Bollard is trying to get at the housing market and has cranked up interest rates dramatically ... Well, higher interest rates tend to support the currency," Mr O'Donovan said.
The governor said yesterday the intervention "does not prejudge the future direction of monetary policy".
But Bank of New Zealand economist Stephen Toplis said the mere fact that the Reserve Bank felt comfortable intervening suggested that, now at least, it had no intention of raising interest rates further.
The Reserve Bank has always said it would not attempt to defend some line in the sand for the currency come what may, but only intervene to shave the tops and bottoms off the exchange rate cycle.
Critics of the 2004 decision to give the bank the power to intervene argued that its limited resources could be quickly exhausted if the intervention was misjudged.
It is easier for the bank to intervene when the currency is high because it can sell its own product - the New Zealand dollar - whereas intervening to stop the dollar from falling further involves drawing down its foreign exchange reserves.
But its capacity to intervene is still limited. If it suffers losses as a result of its intervention, it has to write them off against its capital.
Economist Gareth Morgan said: "Overall, this is high-stakes poker. I think we're gonna end up dog tucker here."
Deutsche Bank chief economist Darren Gibbs said: "The bank has $1 billion worth of capital. Let's say they consider the maximum potential loss here is 20 per cent. That would imply they could, if they want to, sell $5 billion before they would risk exhausting their capital."
Beyond that Dr Bollard would have to go to the Government for more.
Mr Toplis said none of the conditions the Reserve Bank had outlined when it got the power to intervene were satisfied.
One was that the exchange rate must be exceptionally high or low. Certainly it was very high by historical standards, he said, but as Dr Bollard himself emphasised last Thursday, a number of other currencies were also at or near historic highs against the US dollar "so there is really nothing exceptional to speak of".
Intervention also must be con-sistent with the bank's instructions from the Government, the policy targets agreement.
Auckland and Wellington Chambers of Commerce welcomed the move.
But Finance Minister Michael Cullen was noncommittal.
"Today's action is a reminder to people that if they overinvest in the New Zealand dollar they could suffer losses."
National Party finance spokesman Bill English said it was difficult to say if the intervention would work, but "for the sake of exporters we hope it works".
He said he had heard speculation that the Reserve Bank might have used around $300 million during its intervention move yesterday.
He stressed that it was difficult and risky to take on markets in the way the Reserve Bank had as it did not have the resources to turn around a trend in the market.
But it was a judgment call by Dr Bollard to go ahead with intervention, and that was what he was given extra funds by the Government to do, Mr English said.
"The fund was set up for this purpose, and there's no doubt the dollar is overvalued."
- with NEWSTALK ZB
