Will Bollard jawbone the dollar?

The financial markets are braced for the Reserve Bank to do not very much on Thursday.

Reserve Bank governor Alan Bollard is to review the official cash rate on Thursday and he would drop a bombshell if he were to do anything other than keep the rate at 2.5%.

Where he may surprise is in comments on the currency.

The review on Thursday comes with a full monetary policy statement and an updated set of forecasts and it is the Reserve Bank’s outlook for the economy which will be scrutinised more intently than any rate decision.

Both the domestic and international picture have improved somewhat since the central bank’s last MPS in December and even, to some degree, since the official cash rate review six weeks ago.

The big change has been the currency, which has risen steadily since just after Christmas.

Both the New Zealand and Australian currencies are regarded as being considerably above fair value and the question among economists is when, not if, they will fall.

Across the Tasman, Reserve Bank of Australia governor Glenn Stevens went so far as to describe the level of the Australian currency as “a bit odd”.

That was on 24 February, and the Australian dollar responded by moving from US$1.0700 to $US1.0772 by early the following week.

That suggests any similar jawboning by Dr Bollard will have to be considerably more expressive than Mr Stevens. History suggests “jawboning” by central bankers rarely works.

Unless, that is, the currency markets are on the verge of turning anyway. Opinions are divided among economists as to whether that is the case just yet.

Arguing for a near-term drop is the Bank of New Zealand economics team.

“Looking ahead, we still think the balance of risks are skewed in favour of a near-term pullback [on the dollar],” said currency strategist Mike Jones.

“Recent gains in risk appetite have driven the NZD/USD well above what most short-term fundamentals would suggest. Historic relationships with key drivers like commodity prices, interest rate differentials, and relative growth all suggest the NZD/USD is ripe for a small downward correction.”

He emphasizes the “small”, however.

“We’re not expecting a big fall. Indicative of such, our March quarter NZD/USD forecast sits at 0.8100. … Simply put, there is a whole bunch of medium-term drivers that are still stacked in favour of New Zealand dollar strength.”

These include a better outlook for the New Zealand economy, and the likelihood bank interest rates will start rising soon regardless of what the Reserve Bank does.

The high currency does to a certain extent reflect New Zealand’s relatively good economic outlook but it is still higher than it is warranted, said Westpac Bank New Zealand chief economist Dominick Stephens.

“It is clearly positioned higher than justified by the economic fundamentals, and I would not be surprised if we saw Dr Bollard say something similar to Governor Stevens’s comment about the ‘odd’ level of the currency,” he said.

One benefit of the currency at its current levels is it is keeping a lid on inflation, said Goldman Sachs New Zealand economist Philip Borkin.

“You only have to think what the petrol price would be at the moment if the dollar was much lower. So it is helping the Reserve Bank, although it is not the way they would like to do the work of fighting inflation. It’s hitting our growth prospects as well.”