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Cablegate: New Zealand's Reserve Bank Balancing Act - Trying

VZCZCXRO9033
PP RUEHNZ
DE RUEHWL #0452/01 1700649
ZNR UUUUU ZZH
P 190649Z JUN 07
FM AMEMBASSY WELLINGTON
TO RUEHC/SECSTATE WASHDC PRIORITY 4375
INFO RUEHBY/AMEMBASSY CANBERRA PRIORITY 4868
RUEHNZ/AMCONSUL AUCKLAND PRIORITY 1358
RUEHRC/DEPT OF AGRICULTURE WASHDC PRIORITY
RUEATRS/DEPT OF TREASURY WASHDC PRIORITY
RHHMUNA/CDR USPACOM HONOLULU HI PRIORITY
RUCPDOC/USDOC WASHDC PRIORITY 0145

UNCLAS SECTION 01 OF 02 WELLINGTON 000452

SIPDIS

SENSITIVE
SIPDIS

PASS TO USTR, STATE FOR EAP/ANP, EB, INR, PACOM FOR
J01E/J2/J233/J5/SJFHQ

E.O. 12958: N/A
TAGS: ECON EFIN ETRD PGOV PREL NZ
SUBJECT: NEW ZEALAND'S RESERVE BANK BALANCING ACT - TRYING
TO KEEPING BOTH INFLATION AND THE KIWI DOLLAR IN CHECK

REF: WELLINGTON 351

1. (SBU) SUMMARY: On June 11, in what was initially seen as a
surprising move, the Reserve Bank of New Zealand (RBNZ) begun
to intervene for the first time in 20 years in the
international currency markets in an attempt to stem the
rapid appreciation of the Kiwi dollar. Many critics say the
move was very risky, as New Zealand's limited monetary
reserves can not compete with huge international hedge funds
drawn to New Zealand's high 8 percent official cash rate (OCR
-- the Bank's interbank loan interest rate.) Ironically, it
is RBNZ's efforts to keep the housing market and other
inflationary pressures under control by setting the OCR rate
at record rates that is simultaneously driving the value of
the Kiwi dollar up. The conflicting aims of RBNZ monetary
policy - low inflation and lower exchange rate - are leading
the Bank into uncharted territory whose outcome is uncertain.
If the Bank's actions fail to produce the desired results of
lower housing costs and lower exchange rates it may find
itself at the limits of its monetary tools. Not
surprisingly, many economists are calling for other means to
drive down inflation and interest rates, but politically
unpopular proposals such as capital gains on property would
be hard for the Labour Government to push through. END
SUMMARY.

2. (U) In what some analysts see as risky, on June 11 the
Reserve Bank of New Zealand (RBNZ) intervened for the first
time in 20 years in international currency markets in an
attempt to stem the rapid appreciation of the Kiwi dollar.
The move shocked currency markets, and initially the Kiwi
dollar fell nearly US2 cents from a 22-year high of US76.39
cents, to trade under US75 cents. This intervention followed
the raising of the official cash rate (OCR) by the Reserve
Bank by 25 basis points to a record 8 per cent three weeks
ago. (It is now one of the highest rates in the developed
world, see reftel.)

3. (U) Initial business reaction to the intervention was
mainly supportive, particularly among exporters hoping for a
lower Kiwi dollar. Some analysts, however, pointed out that
the move was a risky one. The bank sold approximately NZ$500
million out of a total estimated reserve of NZ $3.5 billion.
The analysts warned that New Zealand's high interest rates
would remain attractive for investors, and it would be
difficult for the Bank to use its relatively small NZ
reserves to outbid those international hedge fund managers
who believe the currency is now undervalued. .

4. (U) These concerns may already have been borne out. The
June 11 intervention had only a short lived success in
decreasing upward pressure on the NZ$ exchange rate. A
second, unconfirmed intervention on the morning of June 18
(size unknown but rumored smaller than the first) saw the
exchange rate fall from about US75.5 cents to US75 cents.
Taking advantage of the local time difference, the action was
carried out while the NZ markets were the only ones open in
order to dampen unnecessary speculation. But by the time the
New York markets closed, the NZ$ had returned to its
pre-intervention rate. Apparently, immediately after both
interventions foreign investors increased their purchase of
NZ$ assets. (NB: In the past, Japanese companies and
individuals have been the most active investors in NZ$
assets.)

5. (U) While the first intervention may have indicated to
some market watchers a glass ceiling of US76 cents, the
second intervention occurred just below 75.5US cents, which
some market analysts believe must be the true set level.
Regardless what the Reserve Bank sees as the breaking point,
NZ exporters are complaining that even the current rate (or
lower) is too high an exchange rate burden for them to
maintain competitiveness overseas. Though the RBNZ is legally
independent in its mandate to set monetary policy some
politicians have expressed surprise and annoyance at the
Bank's lack of prior consultation. Prime Minister Clark and
Minister of Finance Cullen have said publicly that they did
not have prior knowledge of either intervention and have
continued to remain publicly neutral to insure the continued
independence of the RBNZ.

6. (U) COMMENT: Currently RBNZ Governor Bollard has not ruled

WELLINGTON 00000452 002 OF 002


out further interventions or further increases in the OCR
rate and analysts are laying odds on yet another rate
increase sometime this year. Early reactions from investors
and rising commodity prices suggest that the NZ$ will
appreciate again and the RBNZ will be forced to choose
between modifying the exchange rate and the interest rate. If
these conflicting goals remain unresolved RBNZ may enter into
an unsustainable cycle in which it is neither able to keep
inflation within the target band (i.e., between one and three
per cent) nor affect the appreciating NZ$. The present
balance between the two objectives is delicate and could tip
in an unwanted direction as a result of actions by officials
within NZ or by international investors. END COMMENT.
MCCORMICK

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