Reserve Bank's announcements send kiwi diving

11.45am - By SIMON LOUISSON

UPDATED REPORT - The Reserve Bank (RB) made two decisions today to take the heat out of the rampant New Zealand dollar -- and within minutes the currency had plunged nearly a cent.

Firstly, it surprised most private sector economists by leaving the official cash rate (OCR) unchanged at 5.25 per cent.

But more significantly, it has requested Finance Minister Michael Cullen give the bank expanded power to intervene in the foreign exchange market to influence the level of the currency.

The mere request was a shock and signal to the currency market, sending it diving.

The kiwi plunged nearly a cent to US65.75c by 10.25am and was 1.5 cents down from yesterday's closing level.

Bank Governor Alan Bollard wants the bank to have the capacity to use expanded foreign reserves to buy or sell New Zealand dollars when the currency was "unjustifiably" high or low.

The bank believes the kiwi is "abnormally high" at present.

It already has powers to intervene but its stance had been to exercise those only when the market was "disorderly". Since the kiwi was floated in 1985, the bank has never intervened.

Finance Minister Michael Cullen, who boasted in November he had "options" to curb the kiwi, said he was strongly supportive of the bank's proposal and would take it to Cabinet in the near future.

Central bank intervention to influence a currency's direction has been spectacularly unsuccessful around the world.

Speculators and private banks collectively tend to have greater financial reserves than central banks.

Most famously, in 1992, Britain was forced out of the European monetary mechanism when billionaire George Soros and others out-muscled the Bank of England.

Critics argue that where the Bank of England failed, the RB has scant chance of success.

However, other central banks such as the Bank of Japan and Reserve Bank of Australia (RBA) are regular interveners and could claim a degree of success.

Dr Bollard acknowledged there were risks for the bank in operating such a policy and it would require "careful management".

Currently, the RB holds foreign currency reserves of about $3.5 billion and Dr Bollard will request the bank increase that amount by an unspecified but probably significant amount.

He defined "unjustifiable" as meaning when the currency moved in a way unexplained by "economic fundamentals".

"This process is similar to that used for some years by the Reserve Bank of Australia," he noted.

Despite the Reserve Bank of Australia's actions, the Australian dollar's rise against the US dollar has run parallel to the kiwi.

The new tool would help maintain unnecessary exchange rate volatility, Dr Bollard said.

"Importantly, such foreign exchange intervention would not be trying to permanently change the long-run exchange rate," he said.

"At best, we can influence the exchange rate only by small amounts at the extremes of its cycle when it is a long way from economic fundamentals. In doing this, there could be financial risks to the bank requiring careful management."

Dr Bollard said he had in recent days put the idea to Dr Cullen, but the bank had been mulling the concept for over two years. He would not say what influence Dr Cullen had on the decision.

More work needed to be done before final decisions could be made or the operational procedures and capacities were established.

National Party finance spokesman John Key, a former currency market player, slammed the concept as "about as effective as a pop gun in a bank robbery".

"As much as we all have sympathy for the current plight of exporters, currency intervention is the equivalent of a financial mirage," he said in a statement.

"In many respects currency intervention is not dissimilar to tinsel on a Christmas tree -- it looks nice, and makes everyone feel better, but achieves very little," Mr Keys said.

International advice suggested the risk-reward ratio did not justify intervention, he said, noting intervention was most likely to create "false hope and a large public liability along the way."

- NZPA