Dollar's fall tipped to keep interest rates up

The dollar's steep plunge is putting the economy back on an even keel by making life easier for exporters and harder for consumers, economists say.

The currency ended March at 63.3 on the trade-weighted index, an impressive 12 per cent lower than its average level in December.

It is also 7 per cent lower than the average level the Reserve Bank assumed for the first half of 2006, meaning that overall monetary conditions are easing much faster than the bank thought they would.

For the bank's monetary conditions index, a 2 per cent change in the trade-weighted exchange rate has the same effect - stimulus or drag depending on the direction - as a 1 percentage point change in short-term interest rates.

On that basis, the dollar's fall this year is as good as cutting the official cash rate from 7.25 to 1.25 per cent.

Bank of New Zealand economist Craig Ebert said the big correction would be a shot in the arm for hitherto struggling exporters and help who compete directly with imports. He said those two groups, combined, made up about 45 per cent of the economy.

HSBC chief economist John Edwards said Reserve Bank Governor Alan Bollard had made it clear he wanted a seriously cheaper currency to help the economy rebalance towards exports, while keeping interest rates sufficiently restrictive to discourage domestic demand growth and house price inflation.

"Right now he has both, and the further the dollar falls the less Dr Bollard will want to cut the cash rate."

ANZ National Bank acting chief economist Cameron Bagrie believes the stimulus of a lower currency will work faster this time than in the last big downward move in the late 1990s, because exporters are carrying less hedging and corporate balance sheets and cashflows are stronger, allowing them to invest in anticipation of the income boost to come.

BNZ head of research Stephen Toplis said the weaker currency was not the only thing moving in exporters' favour. Forecasts of economic growth among the country's trading partners continued to be revised upwards as well.

"Our contacts with business suggest exporters are beginning to smile. And these smiles are being validated by the investors' community with the share price of listed exporters running hot," Toplis said, citing strong performances over the past month by the likes of Sanford, Fisher & Paykel and Tourism Holdings.

But the heightened inflationary pressure would result in interest rates staying higher for longer, lengthening the domestic squeeze.

Last week's National Bank business sentiment survey found inflation expectations coming down, but still above 3 per cent, while the proportion of firms expecting to raise their own prices went up.

Edwards argues that the severity of monetary policy has been more apparent than real, citing the rising trend in building consents since the middle of last year as evidence of that.

Since the falling exchange rate reflected offshore investors' increasing reluctance to lend long in New Zealand dollars, the bond rate should continue to move up, which "by mid-year may well pose a problem for Dr Bollard", he said.

But given the dollar's decline and the strength of residential construction, he does not expect the Reserve Bank to start cutting the cash rate until the December quarter, which is when the BNZ too expects the first cut.

DOUBLE EDGED

* Dollar's decline is a shot in the arm for exporters.

* But is more of a stimulus than the Reserve Bank expected.

* It may keep interest rates higher for longer.