6 Min Read
* RBNZ Gov says NZ$ over-valued and unsustainable
* RBNZ could sell NZ$ if currency does not weaken
* High currency factor may slow future rate rises (Recasts, adds details, quotes, updates market reaction)
By Gyles Beckford
WELLINGTON, May 7 (Reuters) - New Zealand's central bank on Tuesday warned that it may have to intervene to weaken the country's high-flying currency, and suggested interest rate hikes might be slowed if the kiwi dollar remains elevated.
The forthright comments by Reserve Bank of New Zealand governor Graeme Wheeler sent the New Zealand dollar -- the 10th most traded currency globally -- skidding nearly half a U.S. cent, as markets adjusted to the prospect of a less aggressive tightening cycle.
"If the currency remains high in the face of worsening fundamentals, such as a continued weakening in export prices, it would become more opportune for the Reserve Bank to intervene in the currency market to sell New Zealand dollars," Wheeler said in a speech to a dairy farming conference.
Wheeler said a stubbornly strong New Zealand dollar "will be a factor in our assessment of the extent and speed with which the Official Cash Rate needs to be raised."
Analysts were quick to note that the RBNZ has made similar intervention warnings in the past, but the implications for interest rates weren't lost on domestic markets.
"We do expect that sustained NZ dollar strength will slow the tightening cycle this year," said ASB Bank chief economist Nick Tuffley, who is picking another 25 basis point hike in June. "But, beyond June, continued NZ dollar strength would reinforce our view that the RBNZ would pause until the end of the year."
Faced with rising inflation pressures in a booming economy, the RBNZ started its long-awaited rate-tightening cycle in March, becoming the first central bank in a developed economy to raise rates. Wheeler's latest comments suggest the bank may not apply the brakes too hard.
Another 25-basis-point hike at the June meeting would lift the cash rate to 3.25 percent, following similar-sized hikes in March and April, but a prolonged pause beyond that point would leave rates much lower than the RBNZ's implied projection of 4.25 percent by year-end.
Analysts expect the central bank to lower its projection on interest rates in June.
"Were the currency to hold at current levels, moving into the June MPS forecast round, there would be scope for inflation forecast downgrades, which should also cascade into the RBNZ's rate track," JP Morgan senior economist Ben Jarman said in a note to clients.
The kiwi, one of the 10 most traded currencies globally, has been boosted by dairy export driven terms of trade at 40 year highs, and the central bank's resumption of rate rises boosting its yield attraction for investors in carry trades.
Currency carry traders borrow in countries with low interest costs to fund purchases in markets with higher yields. At 3.00 percent New Zealand's rates are well above the Fed fund's rate of 0.0 to 0.25 percent and even that of Australia which is at 2.50 percent.
The central bank's intervention arsenal is dwarfed by the massive global currency trade, with more than 100 billion New Zealand dollars traded daily -- meaning interest rates remain the biggest tool to manage the kiwi.
The RBNZ has talked intervention in the past and occasionally sold the currency in modest amounts, but Wheeler's comments were his most assertive piece of jawboning since he became governor in 2012.
"We are closer to intervention. It would not be a surprise if they were to do it one day," said Westpac senior currency strategist Imre Speizer.
"It's stronger rhetoric against the exchange rate than we have seen from this governor yet."
Wheeler said the kiwi, which hit a two-and-a half year high of $0.8779 on Tuesday, was overvalued and unsustainable at current levels
He said the currency could be expected to weaken if the Chinese economy were to slow, global dairy prices fall, financial market volatility was to return, and the U.S. economy improved.
The kiwi dropped to a low of $0.8700 from $0.8740. It last traded at $0.8690. So far this year it has risen about 5.8 percent against the U.S. dollar, and in March a visiting IMF team said it was overvalued by as much as 15 percent.
The RBNZ has regularly voiced its concern about the high currency, but has also admitted that it's largely powerless to affect the value other than at the margins, and that any intervention would be to remind investors that the currency was "not a one way bet".
A year ago, Wheeler made a similar sort of speech and disclosed the RBNZ had sold the currency for the first time in five years.
Dairy products provided about a third of the country's NZ$50 billion export earnings in the year to March, with China the biggest buyer. But prices have fallen more than 20 percent over the past two months, and the high currency remains a headwind to export earnings.
A Reuters poll of 17 economists shows all but one expect the RBNZ to raise rates to 3.25 percent in June, and though most economists anticipate rates to rise to 3.75 percent by the end of the year, Wheeler's comment puts the more aggressive market forecasts in perspective.
The "dairy price dynamics are now bringing the currency into sharper focus," JP Morgan's Jarman said, and that would feed into a more modest interest rate tightening track. (Editing by Shri Navaratnam)