It would be ironic if New Zealand, a country once famed for its “laissez faire” approach to economic policy, sparked a wave of fresh intervention in the currency markets.
But Monday’s unprecedented intervention by the Reserve Bank of New Zealand has sparked speculation that the “i” word might creep back onto the agenda of some of the world’s leading central banks.
Mansoor Mohi-uddin, chief foreign exchange strategist at UBS, says: “This week’s action by the RBNZ is the first sign that policymakers are willing to use intervention again more actively to curb misalignments in the currency markets.
“Don’t be surprised if other central banks also consider intervening in the future if exchange rates appear to be seriously under- or overvalued for prolonged periods,” he says.
The RBNZ said on Monday it had sold the New Zealand dollar for the first time since its currency was allowed to float freely in 1985.
Alan Bollard, RBNZ governor, said it had made the decision since the kiwi dollar, which last week rose to a 22-year high against the dollar and a 17-year high against the yen, had hit a level unjustified in terms of economic fundamentals.
Neil Mellor, currency strategist at Bank of New York, believes the RBNZ action could mark a significant turning point for political thinking in the G7 and beyond, especially given the perception that several main currencies are overvalued against their counterparts in Asia, particularly against the yen and renminbi.
These reflect elevated levels of risk appetite among investors hungry for yield.
Comforted by low volatility on global asset markets, investors have funded the purchase of higher-yielding currencies by selling low yielding currencies such as the yen in the so-called carry trade.
Indeed, the euro, pound, Australian and Canadian dollars have all been propelled to highs against the Japanese currency.
Mr Mellor says: “There are many currencies whose values have been pushed above and beyond what could reasonably be justified on the basis of underlying fundamentals and interest rate support.”
The UK, Canadian, and Australian authorities have so far made little comment on the elevated levels of their currencies, but European officials have been more vocal.
Nicolas Sarkozy, France’s president, and Romano Prodi, the Italian prime minister, have voiced concerns in recent weeks over the effect of the strong euro, which has risen by over 15 per cent against the yen since the start of 2005. Analysts expect them to highlight the RBNZ’s actions as an example of what can be done by a central bank in the interests of its exporters.
While the European Central Bank is responsible for monetary policy in the eurozone, it is thought the French government has formulated an initiative that would give politicians more say in currency-related decisions.
Last week, Jean-Pierre Jouyet, France’s European affairs minister, said a dialogue between monetary and political authorities had to be restored within the eurozone. “It must be possible to raise questions of adaption – of interest rates, of exchange rates – in a normal way with the president of the ECB,” he said.
Of course, hopes of concerted action by the main central banks hang on the attitude of the US. A return to currency intervention would mark a sharp turnaround by the US and is thought highly unlikely.
For seven years after their 1996 meeting in Lyon, G7 nations took the view that there were circumstances in which co-ordinated currency intervention was justified.
However, John Snow, then US Treasury secretary, lobbied hard to change the communique wording following the G7 meeting in Dubai in September 2003 to reflect his view that the world trading system worked best with market-based exchange rates.
Mr Snow’s primary aim was to persuade China to allow the renminbi to appreciate. However, that also put pressure on Japan to stop intervening in the foreign-exchange market.
The US stance has been instrumental in keeping yenweakness off the agenda of recent G7 meetings, with communiqués limited to warning of the risks of “one-way bets” – a veiled reference to the threat of the unwinding of carry trades – on the value of the yen.
However, a tougher stance from the US on China could raise European hopes of a concerted G7 effort to act on yen weakness.
There have been increasing domestic calls for the US to step up the pressure on China to reform its currency regime, demonstrated by the expected submission of a bill to Congress on Wednesday. It has been sponsored by a bipartisan group of senators that aims to strengthen the US response to countries that “unfairly value their currency”.
The bill is scheduled to follow the US Treasury‘s release of its semi-annual report on the currency market. However, most observers believe the Treasury will stop short of labelling China a “currency manipulator”, something it has not found any country guilty of in more than a decade.
This scenario would seem to lessen the near-term prospects of co-ordinated central bank intervention, leaving New Zealand’s authorities alone in trying to halt its currency’s rise.
In any case, some observers believe the RBNZ’s efforts are doomed, especially since only last week it raised interest rates that were already the highest in the industrialised world. This was seemingly at odds with its desire to rein in the kiwi dollar.
Clifford Bennett, chief strategist at FxMax, said: “For Mr Bollard to ignore the lessons of history, as well as the power of this fresh wave of global investment diversification, may well come to be seen as the RBNZ’s greatest folly.
“The New Zealand dollar is likely to be increasingly resilient to each wave of RBNZ selling, until finally the central bank is overwhelmed by increased global investor interest that it itself inspired.”
