Dollar unsustainably high, says Bollard

Wednesday 11th November 2009

New Zealand's dollar is "unlikely to be sustainable" at current high levels while the return to looser lending conditions for home-buyers risk return to a debt-fuelled housing cycle, Reserve Bank Governor, Alan Bollard, said this morning.

Releasing the bank's six monthly Financial Stability report, Bollard again expressed fears that the pain the high New Zealand dollar is causing exporters could worsen if debt-driven housing investment brought "further exchange rate pressure and erosion of competiveness."

The kiwi dollar slipped slightly after the announcement to US74.15 cents, from US74.28 cents before the announcements.

However, Bollard urged banks not to "overly restrict" lending to businesses.

With New Zealand still highly indebted by world standards, Bollard is looking for continuation of recent improvements in the current account deficit, but says the outlook is unclear because of the high dollar.

"The scope for sustained rebalancing is being curtailed by the recent strength of the New Zealand dollar. The exchange rate fell sharply over the year to March 2009, which helped to cushion the export sector from the effects of the global recession and deter import demand.

"The exchange rate has risen sharply since March, which is likely to limit further current account improvement over the medium term. The current level of the New Zealand dollar is unlikely to be sustainable. It would be conducive to orderly adjustment if the currency fell gradually, rather than remaining high for a period and then falling sharply.”

He warned also that "extraordinary" levels of fiscal stimulus were propping up current global economic sentiment and that these would need to be slowly unwound. Combined with the global financial system's ongoing vulnerability to further shocks, the sustainability of the current world recovery was not assured.

The banks nevertheless remain very cautious in their credit and funding processes," said Bollard. "While generally supporting this approach, we have continued to emphasise that the banks should not overly restrict lending to the business sector."

However, house prices were still high as a proportion of income than at any time before 2005, and had stopped falling recent momnths because of strong inward migration, much lower mortgage rates, and very low activity in the construction sector.

Bollard warns that some first-home buyers are likely to face difficulty as interest rates start rising.

The RBNZ also has concerns about patterns of rural lending. Deputy Governor Grant Spencer outlined consultations occurring with New Zealand banks to take a more smoothed, "through the cycle" approach to rural lending, rather than lending heavily in good times and withdrawing when the going gets tough.

"We weren't particularly happy with the risk models the banks were using for rural lending," he said. The RBNZ would be requiring changes to those models in coming months.

Ironically, the new models would require banks to hold less capital against rural lending than they are at present, during a period of downturn, than in periods of stronger activity.

Meanwhile, the Bank confirmed a start date of April 1, 2010, for the new prudential liquidity policy that should reduce banks' over-reliance in the past on short term wholesale funding. The policy was to have come in before the end of this year.

Banks would initially be required to hold minimum core funding ratio set initially at 65%, moving in two stages to as high as 75% on a timetable yet to be determined, but which should be complete by mid-2012, the RBNZ says.

The report expects further rationalisations and closures in the non-bank deposit-taking market, especially as the new, higher fees for involvement in the Government's Retail Deposit Guarantee Scheme kick in next year.

Businesswire.co.nz

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