Dollar soars on Reserve Bank Governor's speech

Reserve Bank Governor Graeme Wheeler. Photo / Mark Mitchell.

The New Zealand dollar rose sharply this morning above US73c as Reserve Bank Governor Graeme Wheeler published a speech which outlined reasons he doesn't see the need to take a "slash and burn" approach to interest rates.

In the speech, delivered to the Otago Chamber of Commerce by RBNZ chief exonomist John McDermott , called Monetary policy challenges in turbulent times, he addressed some of the big issues facing central banks globally including low inflation and debate around revising monetary policy targets.

Perhaps ironically - in a speech which also dealt with the Reserve Bank's limited power to influence exchange rates - currency traders seized on the comments which rebutted calls for the Reserve Bank to cut rates harder.

Wheeler reiterated his confidence in the underlying strength of the New Zealand economy.

"With annual growth projected to increase to around 3.5 per cent, rapid and ongoing decreases in interest rates would likely result in an unsustainable surge in growth, capacity bottlenecks, and further inflame an already seriously overheating property market. It would use up much of the Bank's capacity to respond to the likely boom/bust situation that would follow," he said.

"Such consequences suggest that a strategy of rapid policy easing to extremely low rates would be counter to the provisions in the PTA that require the Bank to "seek to avoid unnecessary instability in output, interest rates and the exchange rate" and to "have regard to the soundness of the financial system".

Wheeler also said leaving rates untouched wasn't an option because it risked letting already low inflation expectations bed in, which would drive headline inflation lower.

If expectations sank too far, they would be difficult to lift back up. However, cutting rates more aggressively carried "considerable risks" and would use up the bank's capacity to respond to future shocks, putting it in the same boat as other central banks and running counter to the bank's mandate of avoiding unnecessary instability in the system.

He rejected calls to lower the current 1-to-3 percent annual inflation target, saying that could damage the bank's credibility by making it easier to reach those goals when conditions get tougher.

"There is nothing sacrosanct about what particular inflation band or target should be adopted as a measure of price stability. However, changing a target when times become tougher reduces the incentives on central banks to achieve earlier agreed goals.

It could damage the central bank's credibility - particularly if a perception develops that the central bank will continually seek to respecify goals."

The dollar rose US0.6c to US73.4c before easing back to US72.9c.

- additional reporting BusinessDesk