By BRIAN FALLOW economics editor
The Reserve Bank will stick with its policy of not intervening in foreign exchange markets, except in conditions of severe market disruption, says Governor Alan Bollard.
"We have not intervened in the past and we would only intervene under conditions of severe market disruption," Bollard yesterday told MPs on the finance and expenditure committee.
"We would envisage that to be much more likely in a case where the New Zealand economy was either under severe stress or there were some big shocks from abroad and there were some concerns about the New Zealand dollar falling rapidly. That is our current position and it hasn't changed."
The bank was looking at what tools were available to influence the exchange rate but had concluded there were no "magical new instruments" available.
"The bank's position on that is set out in its report to the Svensson review a couple of years ago when it talks about a number of intervention tools which are possible but concludes there is no free lunch, that most of them have quite big problems around them," Bollard said.
Asked if people overestimated the bank's ability to influence exchange rate movements Bollard said: "As a broad statement that's probably true. Currently the dominant feature which is having an impact on the exchange rate is what is happening in the US and concerns the markets have about the US current account and fiscal deficits."
Clearly there was nothing the bank could do that would affect the markets' view of those deficits.
"That is not to say that what the bank does or says cannot have an effect. It can under certain circumstances. But we are interested in all of this, as the traded sector should be, in the real exchange rate and the longer-term aspects of it because that's what impacts the New Zealand economy," he said.
"But we will keep looking at what instruments are there especially in view of where the New Zealand dollar could eventually get to against the US dollar and the pain that it could cause to the economy."
Bollard said that compared to the mid-90s when the exchange rate was higher - "but not that much higher" - firms were adjusting much better.
"That is because they have understood what the financial markets can do for them in the way of hedging in some cases and natural hedging in other cases compared with five or 10 years ago.
"So I think the Reserve Bank has been under less pressure and there is a broader understanding of what we can do and what we can't do."
Appearing before the same select committee three weeks ago Finance Minister Michael Cullen said the Government was "not entirely without options" in face of the rising exchange rate but has declined to elaborate since then.
Cullen's comments have led to speculation that the Government might instruct the bank to sell New Zealand dollars and buy US currency under cover of a substantial one-off adjustment to its foreign exchange reserves.
Bollard said the bank was carrying out a "first principles" review - the first for many years - of whether its foreign exchange reserves were appropriate.
"We have surveyed other central bank holdings of reserves around other relevant countries and how we rank in terms of how large and accessible our reserves are by a series of different tests. We come out within the pack or a little on the low side."
Hands-off policy in foreign exchange markets to continue
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