NZ$ reaches post-float high of US$0.83 – need for intervention?

After Bollard’s indication yesterday that inflationary pressures were mounting and there would be a tightening of monetary policy of over 2%, the NZ$ reached the milestone of US$0.83 cents. The main reasons for its rise over the last few months are twofold:

1. The weak US economy
2. Global commodity prices for exports including dairy

Below is graph from the BNZ outlining the NZ$ movement during May.

One wonders where the NZ$ will go from here. The BNZ have put together a couple of key NZD risk scenarios:

Scenario 1: The NZ good news continues: NZD/USD rises above 0.8500
Under this scenario, the NZ economic recovery continues to gather steam, and NZ commodity export prices hold up around current record highs, or press even higher. Against a backdrop of recovering economic growth, the RBNZ is forced to respond to rising capacity and inflation pressures and hike rates aggressively. At the same time, the building signs of a US economic slowdown become entrenched and the Federal Reserve is forced to maintain extremely loose monetary policy for even longer than markets currently expect.

Scenario 2: The US bounces back: NZD/USD falls below 0.7500
History tells us peaks in NZD/USD are almost always preceded by a bottoming in the USD. While there’s no doubt the US economy is down and out in the here and now, analysts still expect US growth to build to around 3% by year end. Given this, we are cognisant of the significant upside potential in US bond yields. A material sell-off in US bond markets would reverse the downtrend in US interest rate differentials, contributing to a sustained rally in the USD. Not only would this contribute to a lower NZD/USD directly, but a firmer USD would also knock commodity prices lower, compounding the downward pressure on the NZD.

There has been talk in the media of intervention by the RBNZ in the foreign exchange market to reduce the value of the NZ$ and therefore make our exports more competitive. However will that ultimately work? Official intervention means that the Reserve Bank buys or sells foreign currency in an attempt to influence the exchange rate value. Buying foreign currency with NZ dollars is intended to push down the value of the NZ dollar whilst buying NZ dollars with foreign currency has the reverse effect.

A previous attempt by the RBNZ to weaken the NZ dollar happened in June 2007. This action didn’t work and what was ironic about it was that the intervention took place a few days after interest rates were increased to 8% – this seems inconsistent with what the RBNZ were trying to achieve as higher interest rates usually strengthen a currency’s value. See graph below:

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