New Zealand shows the RBA the way

Lifting interest rates amid a rising currency was a risky but necessary strategy for New Zealand's central bank, and it looks to be working.

As Australians we love to make jokes at the expense of our Trans-Tasman neighbours, but the Reserve Bank of New Zealand's management of interest rates in the face of a rising currency is one to be admired. Notwithstanding some of the differences in our two economies, it took some nerve for New Zealand's central bank to raise rates by 1 per cent earlier this year, despite what was a rising New Zealand dollar at the time.

On March 13, when the RBNZ increased interest rates from 2.5 per cent to 2.75 per cent, it was the first change in over two years. At the time the New Zealand dollar was trading above US86c, around 2 per cent below its all-time high. The bank then subsequently raised the official cash rate three more times to 3.5 per cent, pausing in July when the exchange rate was above US88s. For a small island nation that relies so heavily on its exports, one could call this a rather risky strategy.

It was however a necessary step in order to curb inflationary pressures stemming from a booming housing market which, combined with the introduction of new macro prudential measures, are showing some signs of working. In contrast to the RBA, the RBNZ overlooked the elevated currency and raised rates anyway.

Timing is everything

In hindsight the timing was incredible. In a remarkably short period of time subsequent to when the central bank decided to pause the rate hikes, the Greenback rallied hard to force the New Zealand dollar/US dollar exchange rate back lower. Last week it reached a low near US80c, some 10 per cent below its peak in July.  Was this just sheer luck, or great timing? I believe it was great foresight by governor Wheeler and the board of the RBNZ to make that call when they did.

While it doesn’t appear as though Australia is experiencing inflationary pressures to the same extent, the RBA has started to warn against the risks of rising housing prices. The big question is: does it have the nerve to raise rates ahead of time, or will it wait until the horse has well and truly bolted past the Melbourne Cup finish line?

Perhaps now that the currency has softened a little the RBA should feel more confident to do so sooner rather than later. If our central bank needs a shot of courage then it needn’t look very far -- just across the ditch.

Jim Vrondas is Chief Currency strategist, Asia-Pacific at OzForex, a global supplier of online international payment services and a key provider of Forex news. OzForex Group Limited is a publicly listed entity with shares traded on the Australian Securities Exchange under the code "OFX".