Dollar volatility here to stay

OPINION: The Leader of the Opposition has stated that if elected Prime Minister he intends forcing the Reserve Bank to focus less on inflation and more on currency stability.

If you truly believe he will do this then it would seem a good idea to do two things - buy houses and ship spare money out of New Zealand.

We don't for a second believe Mr Goff is thinking in terms of inflation above 5 percent.

But he could be thinking about something close to that because over the past four years NZ inflation has averaged 3 percent so presumably that is at a minimum what he is dissatisfied with.

House prices tend to rise by an amount above the rate of inflation while fixed interest deposits tend to depreciate in real value.

Therefore his comments - if believed - are likely to accentuate upward pressure on house prices in the next few years.

This will make home ownership even more difficult for low income earners who tend not to have the same ability as those on higher incomes to keep their incomes up with cost of living rises - which is another name for inflation.

And why ship funds out of NZ? Because NZ led the world in targeting low inflation and there is still a gradual movement underway globally toward giving central banks just the one goal rather than a mish mash of targets changed at the whim of the politicians.

If NZ sticks out as abandoning low inflation then one would expect investors to demand a higher risk premium for investing here - hence the lower NZ dollar.

Exporters may be thinking that is a good thing - but they should think again.

Inflation is another name for cost of living increases which is another name (roughly) for cost of business increases given the additional upward pressures on wages and other input costs like electricity, transport, rates etc.

Higher inflation means higher cost increases for NZ exporters and only if the NZD depreciates will they be compensated.

History shows that depreciation is likely - but it is impossible to know when it will occur, and it usually happens in sharp movements rather than gradual steps.

Currency volatility would be increased by targeting higher inflation and not reduced.

Is there anything that can be done about the volatile NZ dollar?

First - it is a physical impossibility to fix the rate unless all export, import, dividend, interest payment/receipt, tourism spending and all other FX transactions were centrally controlled.

One suspects we highly migratory Kiwis would not stick around in such a police state.

The RB has tried to smooth the NZD's peaks - with no sustained success in 2007 near the US 75 cent mark.

The currency initially dipped then soared to a new high against the US dollar in March last year of 82 cents. RB intervention does not work. Jaw-boning by the RB, Prime Minister and Minister of Finance has also been shown repeatedly not to work - but it sells well down on the farm

One could alter interest rates - but this would mean inducing huge uncertainty in household mortgage payments, business debt servicing costs, and increasing housing market volatility.

And if the NZD can rise from US 49 cents to 76 cents this year while the official cash rate is cut from 3.5 percent to 2.5 percent, then clearly interest rates are not always a key driving force - as we have so strongly tried to tell exporters for most of this year when encouraging increased hedging.

One could tax inward investment flows. Think about that one.

We banks are already restricting access to credit because our ability to raise funds offshore has permanently deteriorated.

A new tax would scare even more investors away and push NZ domestic interest rates even higher for business and household borrowers.

One suspects the farmers with floating rate debt might not like that.

There is nothing solid going to come along in the next few years which will reduce NZD volatility. That is why we remain such strong advocates of hedging.

Tony Alexander is chief economist at BNZ.