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Downsides to high interest and strong kiwi dollar

High interest rates and a strong kiwi dollar have their downside

By Gordon Copeland MP, United Future finance spokesman

New Zealand needs to watch very carefully the present combination of high interest rates and a strengthening kiwi dollar.

A brinksmanship is involved in the decision of the Reserve Bank Governor to maintain NZ interest rates at around 1 percent higher than Australia and significantly higher than US and European rates. Coupled with a sharp increase in the value of the kiwi dollar (and the Banks forecast that this is likely to continue), astute international investors have spotted an opportunity to do very well by investing in New Zealand. At the moment they are likely not only to receive the best interest rate around but in addition achieve a foreign currency gain.

Overseas investors are therefore piling into the $NZ thus ensuring that these very desirable outcomes, from the point of view of overseas investors, become more and more certain. It’s like a self fulfilling prophecy.

However this trend may in fact be negative for the NZ economy and its growth. Firstly the rise of the $NZ against both the Australian and US dollars significantly reduces returns to exporters across the board. As a result many exporters, particularly manufacturers, have basically exhausted their scope to absorb their diminished returns. If this trend is left unchecked manufacturers in particular will be burnt off in favour of their overseas competitors who have a growing relative pricing advantage.

The second danger relates to rising debt levels by NZ households and businesses. Higher interest rates are designed to reduce household disposable incomes as a curb on inflation ie to transfer funds from consumption into debt servicing, and to choke off new borrowings. However when new funds flow into New Zealand chasing the higher interest rates offered and the exchange gains available banks tend to aggressively market these extra funds to somewhat gullible kiwis.

Banks after all make their money by lending, and maximise profits by lending more rather than less. However, to the extent that these “supply side” monetary conditions boost private sector borrowing then we are counter-balancing and cancelling out the Reserve Bank’s anti-inflationary justification for having such high interest rates in the first place!

According to classical economics high interest rates are supposed to dampen down borrowing and therefore inflation. However statistics from the 1990s show that, for the reasons set out above, New Zealand doesn’t follow the text book and the private sector borrowing might actually increase, not decrease, when our rates are above those in Australia and elsewhere.

For these reasons I urge Reserve Bank Governor Alan Bollard to research the position carefully and give serious consideration to bringing the OCR rate down to the Australian level sooner rather than later.

This could prove to be the best possible Christmas present for NZ businesses, families, and our ongoing economic growth.

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