Why do I say its futile effort?
When a reserve bank set an interest rate OCR at a level, say 8%, it is effectively mop up any excess money above the equilibrium amount. Any investment proposals that has IRR less than 8% would not be viable, thus the money is better of invested in Reserve Bank. The money is mopped up from the market.
Less money liquidity will effectively stifle economic activity. Only investment projects that is returning higher that 8% will go ahead. Hence economic growth will slow or contract.
So is the textbook economic theory.
So when the Reserve Bank selling down the Kiwidollar, it is effectively increasing liquidity in the market, a move contrary to the first effort of setting higher OCR. In an open economy, where money flows like water to the country that offer higher interest rate, billions of dollars would find home in NZ because its attracted to the higher return than anywhere else.
To sell down the dollar is basically futile effort, because overseas money is attracted to NZ because of higher return, not suposedly cheap currency. RBNZ may succedded temporarily to bring down the Kiwidollar by a cent, but as long as the interest rate remain high, money would still flow in.
What is worse, is that some of these money would find its way into the hot housing market. The thing that RBNZ dont want.
If I were given the chance, I would aggressively lower OCR, making Kiwidollar unattractive, and NZ investment unattractive. Hence this would stifle growth and tip the economy into recession.
Bank likely hoping intervention a one-off
By ALAN WOOD and JAMES WEIR - The Press | Wednesday, 13 June 2007
Despite Reserve Bank of New Zealand (RBNZ) hopes that it will not have to intervene again in the kiwi dollar market, it may be required to do so at peak points in the dollar cycle, economists say.
On Monday, RBNZ Governor Alan Bollard shocked the markets with an unprecedented move to sell the kiwi and drive its value lower, with market experts not ruling out further acts. But such action would not occur willy-nilly – rather at opportune moments when the RBNZ felt it again had the upper hand of surprising currency traders.
The kiwi peaked at a record post-March 1985 float high of US76.40c on Saturday morning, but after the RBNZ selling at on Monday it fell more than US1c The kiwi closed yesterday at U75.30c (from Monday's 75.35).
Canterbury manufacturers – more exposed to export markets than such firms in the larger domestic market of Auckland – have welcomed the move to lower the dollar.
But exporters warned that such intervention would be less effective the more often used, and instead asked that better monetary tools be put in place to quell inflation driven by Government and consumer spending and house price gains.
However, Business Roundtable executive director Roger Kerr said intervening in the currency was a "bad decision" and made monetary policy incoherent. The RBNZ tightened monetary conditions last Thursday by lifting official interest rates to 8 per cent, but driving down the kiwi was effectively trying to make monetary conditions easier, moving in the opposite direction, he said.
Trying to drive the dollar down by selling the kiwi also opened the central bank to the risks of losing taxpayer's money if the currency moved even higher, Kerr said.
Economists said while the RBNZ had an intervention capacity of between $5b and $7b, those levels were not nearly enough to take on the giant reserves held by investors around the world.
Christchurch economist Robin Clements, of UBS New Zealand, said US76c had been rumoured to be the "line in the sand" that had been crossed before Monday's RBNZ action. The RBNZ could intervene again, but it would need to act at an opportune time.
"If they think the currency markets will be basically trying them on, then it's not worth it," he said. It will be used sparingly because clearly it costs a lot of money, and the more often it's used probably the less effective it's going to be."
ASB treasury economist Daniel Wills agreed the RBNZ could move again if it felt it could again take the top off significant gains in the kiwi. The bank had taken advantage of circumstances – like a holiday in the key Australian financial markets that meant intervention was likely to be more effective.
Other favourable conditions, including the kiwi being at "extreme highs" and continued appreciation despite the US dollar being relatively strong versus other currencies.
Creating uncertainty by acting in the market would act in the RBNZ's favour, he added.
But BNZ head of research Stephen Toplis said the RBNZ would certainly be hoping it did not have to act in the markets. "If the investor community decides that the central bank is wrong in its assumptions, then the sheer weight of money (held by other traders) would completely dwarf anything the central bank could do."
Investors would be studying tomorrow's retail trade figures, amongst other data, to judge strength in the economy.
Ironically the Reserve Bank of Australia, which had a reputation of being an "extremely interventionist" central bank, had not even attempted to "jawbone down" the similarly high aussie dollar, Toplis said.
Both the kiwi and aussie were supported by strong commodity prices, which in New Zealand were giving good returns to dairy farmers, feeding into domestic demand and inflation.
Wednesday, June 13, 2007
Why do I say its futile effort?