Graeme Wheeler says if Kiwi dollar stays high it would be 'more opportune' for the central bank to intervene by selling NZ dollars

Reserve Bank Governor Graeme Wheeler has fired a warning shot toward the flying Kiwi dollar, by saying that if the currency stays high it would be "more opportune" for the RBNZ to intervene by selling NZ dollars.

Wheeler made the comments in a speech to the DairyNZ conference in Hamilton this morning. Before his comments the NZ dollar had soared to US87.62c, but a short time after his speech was circulated the dollar had dropped to just below US87c.

The last time the RBNZ intervened significantly in the currency markets was in April of last year, when it sold $256 million worth of currency. Before that the previous time was in early to mid 2008 when a rather more significant $1.6 billion worth was sold.

After the April 2013 intervention, which was only revealed in May 2013, the Governor said that the RBNZ was prepared to "scale up" its currency intervention if it saw opportunities to have a greater influence in the value of the Kiwi dollar. When Wheeler made those comments the Kiwi dollar was actually significantly lower than it is now.

Subsequently and till very recently the RBNZ has seemed more sanguine about the continuing high currency and has appeared intent on not letting that interfere with its plans to raise interest rates to take some steam out of the economy.

But in recent weeks the language from the RBNZ has changed markedly.

Today Wheeler reiterated some of his earlier recent remarks that the RBNZ considered the NZ dollar overvalued and that its current level was not sustainable. He then reiterated that a continued strong Kiwi currency could have an impact on the speed and extent of future interest rate rises. The RBNZ has already hiked rates twice this year with more expected to follow - subject now to what happens with the dollar.

Then Wheeler said: "Further, if the currency remains high in the face of worsening fundamentals, such as a continued weakening in export prices, it would become more opportune for the Reserve Bank to intervene in the currency market to sell New Zealand dollars."

Prior to this Wheeler remarked that the exchange rate could be expected to weaken "if one or more of the following occurs":

• the US economy continues to improve;
• global dairy prices continue to come off their recent highs;
• China’s growth slows;
• financial market volatility begins to rise;
• or there is a global ‘risk off’ event such as a correction in global equity prices.

“If the exchange rate remains strong, it is likely to be reflected in continued low or negative tradables inflation.  In such circumstances, the high exchange rate, along with new economic data, will be a factor in our assessment of the extent and speed with which the Official Cash Rate needs to be raised.”\

BNZ head of research Stephen Toplis said the RBNZ threat to intervene was "very interesting on a number of levels":

• "It shows that the RBNZ really does believe the currency is fundamentally overvalued and can no longer hide behind the rising terms of trade because (a) the currency has risen further from the levels that the high terms of trade had previously justified and (b) the outlook for the terms of trade has deteriorated further.
• "The Reserve Bank will only intervene if it thinks intervention would stand a chance of lowering the currency. It must feel that way and will probably have been heartened that today’s jawboning at least had some impact.
• "The intervention has to be consistent with monetary policy. This means that you can’t be intervening to push the currency lower at the same time that you are raising interest rates. So, today’s comments are also a clear indication that the Bank is contemplating a pause in its tightening cycle while it tries to hobble the NZD."

Toplis said "for now" the BNZ economists were sticking with their published view that the RBNZ raises its cash rate in both June and July.

"But this is highly currency dependent and, the way things are going, a near term pause is looking increasingly likely."

ASB chief economist Nick Tuffley said that although the RBNZ had today "upped the rhetoric" on the high NZ dollar, any intervention "would have its challenges". 

"The RBNZ is in the midst of a tightening cycle, with a widespread expectation of another 150-200bp of [Official Cash Rate] increases yet to come.  Any attempts at intervention will be fighting the underlying interest rate story – notwithstanding the RBNZ’s observation that the interest rate cycle is fully priced in and that some analysts believe there is considerable downside risk to the NZD.

"Our view is that dairy prices are likely to find a bottom over the next few [GlobalDairyTrade] auctions and are likely to recover modestly over the second half of the year.  That would suggest that the risk of continued decline in dairy prices triggering FX intervention is reducing.

"We do expect that sustained NZD strength will slow the tightening cycle this year.  We still expect a June OCR increase, with strong migration, muted impact on 2-3 year mortgage rates of the recent OCR increases, resilience of other commodity prices as some reasons for a further near-term hike.  But, beyond June, continued NZD strength would reinforce our view that the RBNZ would pause after June until the end of the year."

This is the media release from the Reserve Bank carrying details of the speech:

New Zealand’s dairy sector has a bright future, but important challenges need to be managed to ensure it retains its dynamism, the Governor of the Reserve Bank, Graeme Wheeler, said in a speech today.

Mr Wheeler told the DairyNZ conference in Hamilton that the dairy sector makes a vital contribution to the New Zealand economy. 

“Dairy exports make up almost a third of New Zealand’s annual merchandise exports, animal numbers and prices have increased and on and off farm productivity growth has been impressive.”

Commenting on New Zealand’s high exchange rate Mr Wheeler said the strength of the terms of trade, which are at a forty year high, are an important driver. New Zealand’s long-term reliance on foreign savings to finance its investment needs also places upward pressure on interest rates and the exchange rate.  In addition, the high exchange rate also reflects the relative strength of New Zealand’s economy compared to other advanced economies.

“The Reserve Bank considers that the exchange rate is overvalued and does not believe its current level is sustainable. Our exchange rate could be expected to weaken if one or more of the following occurs: the US economy continues to improve; global dairy prices continue to come off their recent highs; China’s growth slows; financial market volatility begins to rise; or there is a global ‘risk off’ event such as a correction in global equity prices.”

“If the exchange rate remains strong, it is likely to be reflected in continued low or negative tradables inflation.  In such circumstances, the high exchange rate, along with new economic data, will be a factor in our assessment of the extent and speed with which the Official Cash Rate needs to be raised.”

“Further, if the currency remains high in the face of worsening fundamentals, such as a continued weakening in export prices, it would become more opportune for the Reserve Bank to intervene in the currency market to sell New Zealand dollars.” 

Mr Wheeler said that dairy debt almost trebled over the past decade, and currently stands at $32 billion. 

“It is concentrated among a small proportion of highly leveraged farms with around half of the dairy debt being held by only 10 percent of dairy farmers”.

Despite the prosperous outlook for the dairy sector, Mr Wheeler warned that even the most dynamic enterprises can lose competitiveness and suffer losses in market share, so there are important challenges to manage.

“On the external front these include the oscillations in global dairy prices, increasing competition from other international suppliers, the risk of slower growth in China, and the need to continue diversifying our export markets, including positioning for the enormous longer term opportunities in the Indian market. On the domestic front, dairy farmers are conscious that high dairy prices can turn around quickly and will need to continue managing their cash flows and borrowings in a prudent manner.”