KEY POINTS:
At 2.35 on Monday afternoon, currency dealers at the Reserve Bank rang foreign exchange traders at commercial banks around the country to sell New Zealand dollars.
In itself, there was nothing unusual in this. The Reserve Bank has its own currency dealing room and often deals in the foreign exchange market to settle foreign transactions on behalf of the Government.
Even when paying hundreds of millions of dollars for something like a Navy frigate, amounts the central bank sells at any one time are usually small, such as $3 million, so as not to influence the money markets.
Typically the Reserve Bank dealers would say something like "give me a price please on three million kiwi", and the commercial bank dealer at the other end of the line would give them two prices - one to sell and one to buy.
If the Reserve Bank dealer then wanted to sell the $3 million, the dealer would say "three yours kiwi".
But this time something was different.
The Reserve Bank dealers were asking for prices on much, much larger amounts of currency than usual, and they were following up by selling the New Zealand dollar.
But it got more unusual.
When commercial banks buy a large amount of a single currency they on-sell some of that currency to other banks to offload the risk that a sudden market movement one way or another will leave them with a loss.
Last Monday afternoon when the five banks tried to offload portions of the New Zealand dollars they'd bought from the Reserve Bank, they found other banks were also trying to sell currency that they had also bought from the central bank.
Although the Reserve Bank had never taken such action in the 22 years the New Zealand dollar had been a free-floating currency, it quickly became obvious to market players what was happening: Governor Alan Bollard had intervened in the currency market in an attempt to drive the New Zealand dollar lower.
Three years after being granted the power to intervene and three days after the kiwi climbed to a record post-float high of US76.40c, Bollard did what many exporters suffering under the high currency and some politicians had been hoping he would do and took action on the kiwi.
When the New Zealand dollar hit its high above US76c overnight on Friday it had nearly doubled from below US39c in late 2000 as New Zealand suffered the worst effects of the Asia financial crisis.
Since then the dollar has climbed steadily during the country's longest economic boom since the 1970s. A dozen interest rate rises since 2003 added to the currency's appeal, drawing in Japanese and European investors who wanted access to the high rates on offer.
But the gains came at the expense of the export sector, which found itself less and less competitive with other countries as the kiwi rose.
In seconds, word of Bollard's intervention spread to currency traders in New Zealand and then around the world.
One currency dealer likens it to a ripple. "You drop a stone on the water and it ripples out and the more that it ripples out the wider coverage it has, and the more people know," he says.
A few minutes later the Reserve Bank hit the five commercial banks for a second time. Just 15 minutes after intervention began, the kiwi had plunged from US76.20c to US75.15c as dealers sold the currency, not wanting to get stuck with a falling kiwi dollar.
In the hours that followed, the Reserve Bank entered the currency market again to try to keep driving the kiwi lower.
The amount the central bank sold hasn't been revealed, for the reason that if the foreign exchange market knew how much cash the central bank had spent and how much it had left, any intervention would be far less effective because speculators would be aware of the Reserve Bank's capacity for further intervention.
However, the Government has said it would indemnify the Reserve Bank for losses of up to $1 billion on the foreign exchange market.
Supposing that the central bank was prepared to wear losses of up to 20 per cent of the amount of currency it sold, that would give it a potential war chest of $5 billion.
Whatever he spent - and it was almost certainly in the hundreds of millions - Bollard's first foray into the foreign exchange market was initially very successful.
By early evening, the kiwi was down to US74.81c - nearly 2c below its peak three days earlier.
It was a well-planned and well-executed hit and met two of the Reserve Bank's criteria for currency intervention.
First, the currency must be "exceptionally high or low - and when, in the Bank's assessment, that level is clearly unjustified by economic fundamentals". And secondly, intervention must be done at a time when there was "a material prospect of influencing the exchange rate".
In April and again last week Bollard had already warned "the exchange rate is at levels that are both exceptionally high and unjustified on the basis of New Zealand's medium-term fundamentals".
So when the kiwi shot up to its record high on Friday night in New York trading, without any fundamental economic news to drive it up, there is little doubt the move attracted the Reserve Bank's attention.
The currency had shot up because US investment bank Morgan Stanley was rumoured to have bought "a yard" of kiwi - the offhand term foreign exchange dealers use when they talk about $1 billion. After the supposed buying - on behalf of a Japanese investment fund - the kiwi hit its post-float high of US76.40c.
What probably concerned the Reserve Bank was that the trade weighted index - a basket of currencies of New Zealand's five main trading partners - had shot up to 74.48, its highest level since December 2005. This is a better indicator of the damage a high currency could do to the economy than the level of the US dollar alone.
Furthermore, the Reserve Bank had an opportunity to do something about the high currency.
On Monday, the Queen's Birthday holiday in Australia meant that the foreign exchange market across the Tasman was mostly closed. So that day, Bollard would get more bang for his buck. Any money the Reserve Bank put into the currency market was likely to have a greater impact than it would on a day when there was more money sloshing around.
There's a third criteria which has to be met before the Reserve Bank can intervene in the foreign exchange market: that intervention is consistent with the Policy Targets Agreement, the central bank's inflation-fighting agreement with the Government.
Some commentators doubt this condition was met. They noted that Bollard tried to bring down the dollar just four days after he'd raised interest rates to 8 per cent in another attempt to cool spending and defeat inflation.
The two actions are incompatible. Interest rate rises slow down inflation and drive the kiwi higher as foreign investors buy the currency to get the high yields on offer here. But pushing down the currency adds to inflationary pressure as imported goods become more expensive and those earning foreign income - such as exporters and farmers - have more money to spend.
The Reserve Bank pointed to the clause in the Policy Targets Agreement that it "shall seek to avoid unnecessary instability in output, interest rates and the exchange rate" as a supporting intervention.
But Stephen Toplis, Bank of New Zealand's head of markets strategy, says the Policy Targets Agreement is primarily concerned with fighting inflation and "the exchange rate is playing a very important role in achieving this".
"We would thus argue that any attempt to lower the currency at this juncture was entirely inconsistent with the Policy Targets' key motivation."
