Wednesday, June 20, 2007

The rise and rise of the New Zealand dollar

New Zealand is a small country by global standards. Yet the New Zealand dollar, like the Australian dollar, has become an internationally traded currency with a weight far beyond the relative size of the domestic economy.

Recently, the New Zealand Reserve Bank has twice taken the unusual step of selling the currency down to try to halt the rise of the kiwi. I was fascinated to hear remarks suggesting that currency flows between the yen and the kiwi were forcing the yen down, the NZ dollar up. On the surface, this is a bit like the currency equivalent of David and Goliath. But then, David did win!

The problem lies in New Zealand interest rates, now some of the highest in the world.

Partly for historical reasons dating back to Rogernomics and the economic troubles of that period, the New Zealand Reserve Bank has always followed a more stringent "purist" approach to monetary policy than its Australian counterpart. To this end, the Bank has raised official interest rates to try to ensure that domestic inflation stays within the target band.

The difficulty for the Bank in all this is that an economy with relatively low inflation, stable economic management and high real interest rates makes the currency very attractive. Add to this the possibility of currency appreciation, and you can see why the Bank has a problem.

I haven't looked at the NZ economy for some time. I should do so.

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