NZ dollar level unsustainable says Cullen

WELLINGTON - The New Zealand dollar is at an unsustainable level and may fall sharply in the face of a ballooning current account deficit and slowing economy, Finance Minister Michael Cullen said on Tuesday.

The New Zealand economy was unbalanced, resulting in the external accounts falling deeply into deficit. But domestic consumption had continued at high levels requiring high interest rates, which were underpinning the country's currency.

Cullen, reappointed last week for a third term as finance minister, told Reuters in an interview that there was excessive faith in the level of the New Zealand dollar and a sharp depreciation was possible. Both Cullen and the Governor of the Reserve Bank of NZ (RBNZ) have previously raised concerns about the level of the currency.

"I'm only saying the same thing the (RBNZ) governor said a couple of weeks ago, but we're both surprised that overseas markets show what, perhaps to quote (US Fed governor Alan) Greenspan, is a certain level of irrational exuberance over the level of the kiwi dollar," Cullen said.

Overseas investor demand for New Zealand dollar denominated bonds -- eurokiwi and uridashi -- was "pretty weird" and "not exactly rational" given New Zealand's current account deficit was at 8 per cent of gross domestic product, he said.

The New Zealand dollar has eased from March's 23-year high, but remains at near 8-and-a-half year highs.

Cullen said a tight government fiscal stance would be maintained to avoid fuelling domestic demand and inflation, which would require higher interest rates.

The RBNZ is widely expected to raise its official cash rate by a quarter-percentage point to a record 7 per cent on Thursday, the first rise in six months, to combat inflation, which hit a five-year high of 3.4 per cent in the year to September 30.

Cullen said he did not see any need for significant revision to the policy targets agreement (PTA) with the RBNZ, which was flexible enough for the size of the New Zealand economy.

The agreement broadly details how the central bank should conduct monetary policy, including keeping inflation between 1 per cent and 3 per cent on average over the medium term.

However, the official cash rate was less effective as a monetary tool than five and 10 years ago, which might require the government and central bank to work more directly together in trying to slow down consumer borrowing.

In the meantime, the use of higher interest rates to combat demand when the economy was slowing might result in a hard landing, he said.

"We are seeing some signs of that slowdown occurring but perhaps not as much as previously predicted and the risk, of course, is that if consumption carries on strongly then that may lead to a much harder landing than is desirable."

- REUTERS