27 Apr 2012

Reserve Bank's approach to dollar could backfire

6:34 am on 27 April 2012

There are warnings the Reserve Bank's attempt to talk down the high New Zealand dollar by threatening to keep interest rates on hold, or even cutting them, could backfire.

The bank on Thursday held the Official Cash Rate on hold at the record low of 2.5%.

But Reserve Bank Governor Alan Bollard's comments have disappointed many in the market, with some even warning the bank's approach could backfire.

The Reserve Bank is stuck between a rock and a hard place. The New Zealand dollar remains high, hurting exporters and an export-led recovery.

But holding interest rates, or even cutting them, to try and bring down the Kiwi, could fuel inflation and also the housing market, particularly in Auckland, where it's showing signs of picking up.

BNZ senior economist Craig Ebert says Dr Bollard's attempt to use interest rates to lower the dollar could prove to be dangerous.

He says if the Reserve Bank cuts interest rates further it could overstimulate the domestic economy, which would lead to inflation pressure, causing interest rates to go back up again leading to market volatility.

Mr Ebert says those looking at the foreign exchange rate see it as a one way bet because Dr Bollard is underwriting a further strong pick up in GDP and in the meantime the currency is probably going to go up.

He says the Reserve Bank was slow to pick up on rising inflation in 2003 and currency traders used that to their advantage.

Council of Trade Union economist Bill Rosenburg says the Government needs to consider alternative tools to tackle the dollar.

He says controlling the amount of overseas funding banks use to fund their lending, to reduce the amount of overseas funds that come into New Zealand and therefore push up the exchange rates.

"Another approach is to do the kind of things that Brazil is doing in the face of flows from the United States with their quantitative easing and put financial transactions tax on short term money flows into the country", he says.

Analysts say it may take a few days for the international currency markets to digest Dr Bollard's comments, but say overall, they're unlikely to have any impact on the dollar.