Wednesday, July 23, 2014

Kiwi intervention by RBNZ? | The topsy turvey world of economics

The Reserve Bank of New Zealand (RBNZ) announced its interest rate decision last evening, GMT. As expected, core interest rates were increased by 25 basis points, to 3.5%. In its accompanying statement, the central bank said that New Zealand’s economy is expected to grow at 3.7% over 2014; construction in NZ is growing strongly; strong net immigration is adding to housing demand; strong growth in output has been absorbing spare capacity, which is expected to add to non-tradables inflation; and, while there will now be a “period of assessment” before the next interest rate rise, the language of the statement is unambiguously about continuing tightening of monetary policy.

All of these things should be strongly supportive of the NZ dollar. So why, then, at the very moment when the announcement was made, did it go through the floor against all of its major counterparts, taking our long position with it? The comment in the statement to the effect that “…the level of the New Zealand dollar is unjustified and unsustainable and there is potential for a significant fall” should give us a clue. The answer to the totally counter-intuitive move by the Kiwi last night has to lie in strong intervention by the RBNZ in the currency markets.

The topsy turvey world of economics

For a great many years the great bugbear of all developed economies was the inexorable rise in prices and the vicious circle of wage demands, leading to further price rises, which fuelled inflation. People in authority wrung their hands and lamented this situation.

Now the whole thing is turned on its head. As evidence of this we have no less a person than the chief economist of the Bundesbank, Jens Ulbrich, calling for wage increases across the board. This call has been echoed by others, including central bankers. The reason is the fear of deflation in nearly all jurisdictions and dire warnings by the IMF, and others, of the serious damage that this can do to global economic growth. It will be interesting to see how it plays out.

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