RBNZ 'swimming against current' and prescribed the wrong remedy

New Zealand subscribe to the open economy dogma. Its free market, not much control whatsoever. RBNZ can only use interest rate as a tool to influence the firection of the economy.
Problem numero uno: Housing market bubble.
Which result in hot consumer good market because home owner feel rich and buy things. Add to these, the world commodity market is booming, and New Zealand has been getting good returns on its milk products.
So RBNZ has been trying to dampen the economy by increasing interest rate.
By raising interest rate, more money flow into New Zealand. Exchange rate gone up to stratosphere.
Swept on global currents
Sunday Star Times | Sunday, 17 June 2007


Despite his extraordinary intervention, forces driving the kiwi are beyond Bollard's control. Tim Hunter reports.


The dollars keep flowing in - $100 million here, $48m there. Each deal ratchets up demand for New Zealand's currency, demand that pushed the kiwi to a record high of US76c a week ago and triggered unprecedented action by the Reserve Bank on Monday.

The bank's interventionist cattle prod jerked the kiwi back to about US75c, but it's still in the stratosphere compared to its long run average around US60c.

The question is, has the prodding made buyers of kiwi more cautious?

And who are these people anyway?

On the same day bank governor Alan Bollard was selling kiwi dollars by the million, Bloomberg carried a story about Michiko Takeda, a 46-year-old housewife from Sapporo. Last year she deposited 2 million yen (about $20,000) with ANZ in Australia for one year, attracted by interest of 7% compared to the 0.35% she could get with Mitsubishi UFJ Financial Group.

"Even with exchange-rate risks, I'd like to invest more," she told Bloomberg.

There are lots of people like Takeda in Japan, and in other countries where interest rates are low, such as Switzerland. For them the deal is simple - they want to invest in the higher interest rates available in other countries.

New Zealand has the highest interest rate of industrialised countries at 8%, but there are attractions elsewhere - Turkey, for example, can offer deposit rates of more than 18%; Brazil's benchmark rate is 12%, down from 19% 18 months ago.

The risk of investing in currencies is considerable. In the last two years $1 has varied in value between 68 yen and 91 yen -get your timing wrong and any interest rate gains are obliterated by adverse currency movements. Get lucky, though, and gains are multiplied many times.

But Takeda is unusual in opening a deposit account overseas. Most retail investors buy their kiwi investments from domestic institutions - an arrangement that conveniently funds mortgage lending here in New Zealand.

The funding trail is revealed in bland bond issue reports - on May 25, for example, the AAA-rated World Bank raised $633m with an issue of uridashi bonds, marketed to Japanese institutions and the public by Daiwa Securities. The bonds were paying 6.76% on face value.

These issues - by institutions like German state-owned KfW, Swedish Export Credit Corp, Toyota Motor Credit Corp - happen several times a month. Since January they have raised $4.313 billion, according to figures from the Reserve Bank.

The same thing goes on in Europe, where instutions like Rabobank and Inter American Development Bank raise NZ dollars by issuing eurokiwi bonds - $5.015b worth since January.

How much of this activity contributes to buying pressure on the kiwi is hard to calculate because some of it will be rolled over from previous issues, but cumulatively there has been huge growth in the trade.

Netting out issues and redemptions, the amount outstanding on uridashis has risen from zero in January 2003 to $21.87b two weeks ago.

Eurokiwi issuance is bigger still. Over the same period eurokiwi debt outstanding has risen from $12.07b to $34.2b.

That's a total of $56b. To put that figure into perspective, total NZ dollar funding in New Zealand banks is $200.9b.

Unfortunately the precise destination of the $56b is unknown, but the bulk of it appears to be funding bank loans in New Zealand through swap deals arranged overseas.

These deals work because overseas investors want to tap into high kiwi interest rates, but prefer to do it through familiar AAA-rated institutions rather than unknown NZ banks. So the World Bank can raise NZ dollars from European and Japanese investors at a fixed rate -with uridashis and eurokiwis - much more cheaply than ANZ, say.

But the World Bank doesn't want kiwi, it wants greenbacks or euros.

ANZ, meanwhile, can borrow euros at a variable rate, so it swaps the euro funds and variable interest rate for the World Bank's fixed rate kiwi at a "swap" rate that allows both to gain advantage from the deal.

These swaps have been hugely beneficial to New Zealand borrowers, much to Bollard's frustration. At times, notably in mid-2005 and the first half of 2006, swap rates have been below the official cash rate, so NZ banks able to access this market could offer highly competitive fixed rate deals.

The effect on house prices is another story, but what of the effect on the dollar?

Some commentators have focused on the unwinding of uridashi and eurokiwi bonds as likely to trigger a dollar drop. In October, for example, $1.6b of eurokiwi and $2.2b of uridashi are due for repayment.

The redemptions may have an effect, but they haven't in the past. As long as overseas investors continue to want to hold kiwi they will simply roll over the money into another kiwi bond.

Economist Anthony bYETT of FX Matters picks investor psychology as the deciding factor. A change in sentiment, some negative press coverage, and enthusiasm for uridashis and eurokiwis could evaporate.

"There's a fairly naive investor on the end of all this," he said. "They're offered a handsome return compared to the local post office, but I don't think they really understand the currency risk."

Byett sees a potential turnaround towards the end of this year, particularly if Japan's central bank raises interest rates.

If that happens, the effect on the kiwi will be amplified by hedge funds, whose currency deals are much larger than those in the swaps trade. Rumour has it that over the two weeks before Bollard's intervention, hedge funds bought between $5b and $10b.

This is the infamous "carry trade", where big funds borrow at low rates to invest in high interest rate currencies. These funds differ from the swap trade investors in that they invest for the short term, perhaps only a few weeks.

If retail investors like Takeda don't care about currency risk, the hedge funds certainly do, and on that score the Reserve Bank's currency intervention made global markets sit up and concentrate.

Byett described the bank's approach as "guerilla action", taking an opportunistic position in the market rather than drawing up battle lines.

"If you see the dollar spike up a cent or two it's a good time to sell," he said. "But if you get a data event next week that pushes up the likelihood of a rate rise, the dollar will be back up to 76c.

"Will the bank intervene again? I'm not so sure."

Here is your chance to ride a Rising Currency

Do a Yen carry trade.
ie; borrow from a low interest, uninspiring stable currency like Yen and invest in a country with high interest rate and rising currency.
definition of stable and/or devaluing currency - economic growth of the country is low, say less than 2% pa. and the country is awash with savings such that interest rate is perpetually low.
definition of appreciating currency - economic growth is high, say above 3%, and the savings rate is low, such that the country need foreign funds to finance their growth.
Let take example of Japan's interest rate, its virtually zero. The country is awash with funds because of its traditionally high savings rate. If you could borrow money in Japan, and invest it in New Zealand at 8% pa, you have got it made.
Not just you will be pocketing the difference in interest rate (say you borrow money at 3% pa and invest it in NZ at 8% pa), but you would also make money when NZ currency appreciate vis s vis Japanese Yen.

Who will lend me money?

Bollard accused of 'kick in guts'
By TRACY WATKINS - The Dominion Post | Friday, 8 June 2007


ROBERT KITCHIN/Dominion Post
UP UP UP: Reserve Bank Governor Alan Bollard has raised interest rates again and pointed the finger squarely at debt-laden households.


Interest rates are looming as a crunch election issue after the Reserve Bank pushed its rates to a record high.
YOUR SAY ON INTEREST RATES RISE ... KIWI EXPECTED TO STORM US80c ... RATE RISE FAILS TO IMPRESS EXPORTERS ... DAIRY FARMS ON ECONOMY THREAT LIST


Reserve Bank governor Alan Bollard pointed the finger squarely at debt-laden households.

As the bank moves to curb inflationary pressures, some economists are picking that rates will rise again as early as next month.

"It's not the Reserve Bank doing this," Dr Bollard said.

"It's the buildup of debt by New Zealanders who overwhelmingly want mortgage finance and who are unable to finance it from other New Zealanders because the household sector isn't saving here."

Dr Bollard lifted the official cash rate for the third time this year to a record 8 per cent from 7.75 per cent.

That is expected to push fixed mortgage rates above 9 per cent.

Floating mortgage rates are already above 10 per cent.

Auckland Chamber of Commerce said it was a "kick in the guts" for exporters struggling to remain competitive as the Kiwi dollar soared.

Companies have announced job losses because of the pressure on export prices from the high dollar.

It hit a record US75.6 cents yesterday, and has been one of the strongest currencies against the US dollar in recent months, driven by our high interest rates.

Dr Bollard acted despite "tentative" signs of a slowdown in the housing market, saying his hand was forced by a third wind in the housing market in the first few months of the year, labour shortages, an increase in government spending and a "shock" windfall in dairy prices that is expected to burn a $2 billion hole in farmers' pockets during the next two years.

He immediately won support for his move from one economist, who said years of good economic news had given rise to a "bullet-proof generation", who had ignored the Reserve Bank's previous warnings because they had only ever seen house prices rise.

"They've never seen tough times," ANZ chief economist Cameron Bagrie said. Every time the economy looked like slowing, it bounced back.

"You've got an economy here that's literally bursting at the seams ... You've got an economy that, on the face of it, appears bullet-proof, but behind the scenes everyone knows it's very vulnerable.

"The housing market could turn very aggressively, things could turn sour very aggressively."

The Reserve Bank has been frustrated in its attempts to cool the housing market, with home owners signing up for fixed-rate terms of an average of 20 months.

It has also seen consumer spending rebound sharply, driven partly by the Government's Working for Families package.

Interest rates were a weapon at the last election, with Labour raising fears that tax cuts by National would push rates higher.

But with the rates now the highest in the industrialised world, National is pointing the finger at Labour for loose government spending that it says will drive interest rates up higher for longer.

National leader John Key said yesterday's interest hike was not needed.

Mr Key said Dr Bollard had not given previously rises enough time to impact on the housing market or spending.

"My view is that he didn't need to raise interest rates yesterday," he told Radio New Zealand. "He could have given it some time to flow through because. . .certain parts of the business community and the housing and private sector consumption areas are increasingly becoming much weaker."

Mr Key said the increase in the payout to farmers was a factor but mortgagees would be feeling the pain.

"Yes, dairy is likely to put some significant stimulus into the domestic market but you shouldn't also discount the fact that there are an awful lot of people now who are renegotiating their mortgage," he said.

"They are paying a considerable increase in their outgoings. The average mortgage in New Zealand is $135,000. On the renegotiaton, roughly, you will be spending about $35 to $40 a week more just to service your mortgage and in some parts of New Zealand like Auckland that could be two or three times that number – that's a huge amount for the average New Zealand worker."

Mr Key said Dr Bollard was trying to regain credibility after previously threatening hikes but taking a long time to act.

"He's now decided that he's going to win this contest and it's in a sense a game of chicken with the New Zealand housing market and one that he intends to win.

"My view is that he will continue to raise interest rates until the housing market stops in its tracks."

After Dr Bollard's announcement the New Zealand dollar rose to a fresh record of US75.6c and Mr Key expected it to go as high as US80c. Factors included high interests rates attracting Asian investors and the United states economy slowing down.

"We can track up as high as 80 cents and frankly we could do it reasonably rapidly within the next few months is possible."

National blame Government spending for fuelling inflation and Mr Key said as that was something Dr Bollard could not control the private sector was feeling the brunt.

"He's decided that because he can't control the Government and because the Government won't reign in its expenditure. . . he's now going to go into direct collision course with the private sector."

Yesterday Finance Minister Michael Cullen questioned what National would do differently after National finance spokesman Bill English made the same argument.

"Mr English's sweeping attacks on government spending are misleading voters. When is he going to explain to voters what National would cut?" Dr Cullen said.

"Cheaper doctor visits? New roads and rail. New schools and hospitals?" - With NZPA