Why the NZ exchange rate is unjustified and unsustainable

Release date
25 September 2014

The Reserve Bank considers the level of the exchange rate is unjustified and unsustainable, and that it is susceptible to a significant downward adjustment, Governor Graeme Wheeler said in a statement today.

Mr Wheeler said the Bank would welcome a move towards a more sustainable exchange rate level.

In today's statement, Mr Wheeler said that, when assessing the implications of current strength or weakness in the New Zealand dollar, the Bank focuses on two broad concepts – whether the exchange rate is unjustified, and whether it is unsustainable.

The level of the exchange rate is unjustified when it is inconsistent with the economic factors that typically explain its movement during the business cycle. It is unsustainable when it deviates from its long-run equilibrium level, where it would be expected to settle when business cycle factors have fully dissipated.

"The Bank's analysis indicates that the real exchange rate is well above its sustainable level, and also above levels justified by short-term business cycle factors," Mr Wheeler said.

"Unjustified and unsustainable are important considerations in assessing whether exchange rate intervention is feasible. Another consideration is whether conditions in the foreign exchange markets are conducive to intervention having an impact on the exchange rate.

"The real exchange rate has not adjusted materially to the recent downward movement in commodity prices. For example, global dairy prices have fallen by 45 percent since February 2014.  Despite this, in August, New Zealand's real effective exchange rate was 1 percent higher than its February 2014 level."

Mr Wheeler said that past experience suggests that, when the New Zealand dollar begins declining from an unjustified and unsustainable level, the ultimate adjustment can be large.

The statement released today discusses why the exchange rate has been strong, why the Reserve Bank believes the level of the exchange rate is ‘unjustified and unsustainable', and the impact of the high exchange rate on the broader economy.  It also looks at episodes of exchange rate correction in New Zealand, and draws possible implications for future exchange rate adjustment.

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