Dollar strength may derail recovery - Bollard

Reserve Bank Governor Alan Bollard. Photo / Mark Mitchell

Reserve Bank Governor Alan Bollard fears the strength of the kiwi dollar may derail New Zealand's "tepid" economic recovery and he can do nothing except hope that the world's major economies can resolve their own currency tensions.

Bollard's comments following the release of the Reserve Bank's twice yearly Financial Stability Report this morning come as Prime Minister John Key heads to Japan for the Apec summit.

Key has said he expects US moves to devalue its currency and the subsequent damage to export economies throughout the Asia Pacific Region will be high on the agenda.

Bollard said the New Zealand economy was rebalancing towards the tradeables or export sector in what he said was a "tepid" recovery to date. However recent indicators suggested the pace of that recovery had slowed, and "pressures on the New Zealand dollar are not helping".

Should the New Zealand dollar remain at or near its current levels, "this will make the continued rebalancing of economic activity towards the tradeables sector difficult to achieve".

Bollard said the US Federal Reserve's latest quantitative easing programme - or injection of new money into its economy - were supporting some markets "but they are also putting pressure on capital inflows and exchange rates in third country economies, which is problematic for international rebalancing".

He again emphasised the Reserve Bank could not and would not try and control the level of the New Zealand dollar by intervening in currency markets.

"There's no way New Zealand can stand in the market against something which is being driven by the major economies offshore and that's always been the case."

He also said "macro-prudential" controls - including regulation of banks' capital reserves as suggested by the Labour party as key plank of its policy around the Reserve Bank's management of the economy - would have little effect on New Zealand's currency.

If the dollar was being bid up as a result of the actions of the large economies "then it's very limited what New Zealand can do".

"New Zealand now as always has got to do the best it can in a difficult world in a realistic sort of way."

Illustrating his point, Bollard resorted to what he said was a Swahili proverb: "When the elephants make love or war the grass gets crushed".

Bollard said he hoped this week's G20 meeting of major economies - which including commodity exporting countries with similar interests to New Zealand - would make some progress in addressing currency tensions.

"It's not in the interests of the major economies to do unilateral things which lead to more broader problems and think that's come home to them."

On the domestic front Bollard said households and businesses were keeping spending low and paying off debt. Combined with improved prices for key exports, "this is reducing New Zealand's current account deficit and external indebtedness, both of which are positive for financial stability".

Deputy Governor Grant Spencer who heads the Reserve Bank's financial stability operations said New Zealand's banks remained in "good shape", having improved the stability of their funding in the last 12 months.

The Reserve Bank has been concerned over the last two years about the extent to which the four large Australian banks who dominate New Zealand's financial system were reliant on international markets which froze up during the financial crisis. Earlier this year it introduced a "prudential liquidity policy" which required them to increase use of domestic and longer term international funding.

"This has reduced a major source of vulnerability," Spencer said.

Spencer also noted that the rate at which banks' loans to customers were going bad was now stabilising after rising steadily for three years and the Reserve Bank expected to see further improvement there.

"Risks to this outcome would arise if the current softness in house prices were to become accentuated or if agricultural export prices were to drop off their current high levels."

Outside the big banks, the Reserve Bank said other savings institutions such as building societies and credit unions were generally performing well.

The Reserve Bank noted South Canterbury's failure two months ago but Dr Bollard did not believe that was having an impact on financial stability in the South Island and the effect of the Canterbury earthquake was also likely to relatively minor

The Reserve Bank, whose oversight of finance companies will be extended next month to include minimum capital requirements, liquidity levels and governance standards, expects further consolidation in the sector in coming months.