What the RBA can learn from the RBNZ

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Reserve Bank of New Zealand (RBNZ) Governor Graeme Wheeler has done it again; defying expectations to intervene in a market to overcome a problem he couldn't fix with conventional monetary policy.

"Wheeler's second big intervention in his two years as Governor appears to have been effective."
Bernard Hickey, Publisher, Hive News

Fresh from creating a macro-prudential tool to restrict the growth of riskier mortgage lending, Wheeler this week confirmed that he had intervened in the currency market to push the New Zealand dollar down.

The central bank quietly confirmed on Monday that it sold a net $NZ521 million worth of the currency in August and had bolstered its foreign exchange intervention capacity by $NZ938 million to $NZ9.558 billion.

The confirmation followed a detailed “final, final warning” statement from Wheeler last Thursday, that explained why the New Zealand dollar was extremely and unjustifiably high and why intervention was being considered.

Even so, the confirmation surprised many in the market who had become inured to the Governor's many warnings about the currency and his previous apparent ambivalence about intervention.

The New Zealand dollar fell more than a cent on the news and has fallen more than four cents to around US78c since Wheeler's final warning last week.

It's still early days, but Wheeler's second big intervention in his two years as Governor appears to have been effective. 

The Reserve Bank of New Zealand has faced many of the same problems faced by the Reserve Bank of Australia (RBA) over the last year and has been one step ahead with policy innovations to deal with them.

Just as in Australia, New Zealand's house price inflation threatened last year to gallop out of control as leveraged investors used historically low interest rates to compete for limited supplies of homes.

Yet the house price inflation has not been accompanied by the consumer price inflation that would normally trigger interest rate hikes needed to shut down the party.

Wheeler's response in the face of much scepticism from bankers and politicians was a limit on the growth of highly leveraged mortgages.

Imposed in October last year, the bank reckons it helped reduce the pace of annual house price inflation from 10 per cent to 6 per cent and bought the RBNZ an extra three to six months of flat interest rates.

The central bank has since increased its Official Cash Rate by 100 basis points to 3.5 per cent, taking more steam out of the housing market, but also increasing pressure on the New Zealand dollar.

The currency's surprising strength this year despite slumps in dairy and log prices has been a constant source of frustration for New Zealand's policy makers, just as it has been for RBA Governor Glenn Stevens.

Wheeler warned about the high New Zealand dollar 13 times in the last two years, but was circumspect about the benefits of intervention for most of that time.

As recently as March, Wheeler pointed out that the New Zealand dollar was between the 7th and 10th most traded in the world, with turnover of $NZ100 billion a day – most of which was in offshore markets.

"The opportunities for intervention, given those sorts of flows, are extremely limited," he said in March.

So what changed and what lessons could the RBA draw from Wheeler's change of heart?

Firstly, as Wheeler pointed out last Thursday, the New Zealand dollar actually rose 1 per cent between February and August, despite a 45 per cent fall in commodity prices.

He pointed to the bank's own measure of the real exchange rate being 25 per cent above its average since 1964 and the IMF and Peterson Institute's estimates that the Kiwi dollar was 5 per cent to 15 per cent over its fundamental value.

Secondly, the Reserve Bank saw that currency intervention would not directly conflict with a monetary policy tightening, as would have been the case between March and July when it was hiking the OCR.

Thirdly, the RBNZ could see it was pushing on an open door during the more lightly-traded Northern Hemisphere summer months of August and September, and as talk of rising US interest rates bolstered the US dollar. 

The RBNZ specifies the 'opportune-ness' of intervention as one of the 'traffic lights' it considers when intervening. The more 'opportune' the moment, the more likely intervention will be effective.

Political cover has also helped the RBNZ. Former currency trader and freshly re-elected NZ Prime Minister John Key provided that cover less than two hours before the Reserve Bank's disclosure of intervention on Monday.

Speaking to reporters as he struck a new Government-forming deal with a minor party, Key said he agreed with Wheeler that the currency was fundamentally over-valued and that currency intervention was "fairly logical."

This contrasted with previous comments by Key skeptical about the effectiveness of intervention. He even went on to say the "Goldilocks" level for the current – not too high and not too low – was around US65c.

"I've never been of the view that currency intervention as a way of essentially turning around an exchange rate and acting against the fundamentals will be successful, because the long term analysis of that doesn't support the view that it works," Key said.

"What does work though is targeted interventions at times where the currency is either over-performing or under-performing, and that will be the basis for their action, if they've acted."

Wheeler could not have said it better himself. Less than two hours later the Reserve Bank confirmed intervention.

Debate in recent months in Australia has shifted towards whether RBNZ-style macro-prudential controls could be used to slow the housing market without damaging the wider economy.

Will the same sort of pressure now grow for RBA currency intervention? It holds the promise of providing relief for manufacturers and exporters without having to cut interest rates – a key factor in the bank's concerns about the rental housing market.

The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.

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