The Reserve Bank is fighting a losing battle trying to talk down the value of the New Zealand dollar, BNZ currency strategist Mike Jones says.
Last week, Reserve Bank governor Alan Bollard tried to stare down the foreign exchange traders by hinting that a fall in the official cash rate from its record-low of 2.5% was possible if the dollar's value did not fall.
Mr Jones said the dollar "thumbed its nose" at the Reserve Bank's talk.
Since late last week, the kiwi had risen from US81.34c to trade around US82.17c yesterday.
"Nothing has stuck - plunging New Zealand commodity prices, Reserve Bank jaw-boning, ailing global risk sentiment and falling local interest rates. Despite all of these supposed negative influences, the New Zealand dollar-US dollar has remained stubbornly strong."
The currency had spent the last two and a-half months drifting aimlessly sideways in an elevated US80.8c to US82.8c range, he said.
Dr Bollard's increasing frustrations with the "teflon currency" were obvious in the Reserve Bank's OCR statement when he more or less threatened the currency markets with a rate cut.
Mr Jones believed the Reserve Bank's currency obsession was misplaced and unhelpful. It was not clear interest-rate cuts would get the dollar lower.
The key medium-term driver of the dollar was still how New Zealand economic prospects compared to its trading partners.
A lower OCR would boost New Zealand's relative growth prognosis and probably increase the need for interest rate hikes down the track.
That sounded like a recipe for an even stronger dollar, he said.
The Reserve Bank's increased currency focus meant interest rates were switching from being a dollar driver to being dollar reactive.
If the trade-weighted index (TWI, a basket of currencies of New Zealand's trading partners) did not fall as the central bank expected, the market would price out OCR hikes or even price cuts. Wholesale interest rates would fall.
Conversely, if the TWI collapsed, the market would price in earlier rate hikes. .
"It's almost like the Reserve Bank has taken a step back towards the old approach of targeting both the currency and interest rates - the much maligned MCI (Monetary Conditions Index) framework.
"No wonder the currency has shown little reaction to interest rate movements of late."
Whatever the merits of Reserve Bank policy, the risks seemed to have moved in favour of the bank holding rates at 2.5% for longer.
Mr Jones was not sure intervention would stand a reasonable chance of success as the Reserve Bank would be "leaning against" the Federal Reserve's highly accommodative - US dollar suppressing - policy stance.
However, the central bank could also intervene in the currency more discretely to try to smooth the peaks and troughs of the cycle.
"As long as the currency remains stubbornly high, we wouldn't be surprised to see the Reserve Bank quietly net selling New Zealand dollars in coming months," he said.
Dollar intervention
Four aspects need to be satisfied before the Reserve Bank can consider intervention in the dollar. They are.-
• The currency must be exceptionally high or low.
• The currency must be unjustified relative to economic fundamentals.
• Intervention must be consistent with monetary policy and the Reserve Bank's responsibility under the Policy Targets Agreement.
• Intervention must be opportune - it must have a reasonable chance of success.
