Kiwi falls and may drop further in reaction as OCR lifted to 3.5%

The odds the Reserve Bank will intervene in the currency market to push down the value of the New Zealand dollar strengthened significantly yesterday.

The central bank lifted the official cash rate (OCR) to 3.5% - a move not unexpected despite calls from many for it to hold off - but riled against the inconsistency between falling commodity prices and the very high exchange rate.

''Over recent months, export prices for dairy and timber have fallen, and these will reduce primary sector incomes over the coming year. With the exchange rate yet to adjust to weakening commodity prices, the level of the New Zealand dollar is unjustified and unsustainable and there is potential for a significant fall,'' Reserve Bank governor Graeme Wheeler said.

Westpac chief economist Dominick Stephens interpreted the choice of Mr Wheeler's language as a direct warning of intervention.

The reaction on foreign exchange markets was vigorous.

The kiwi fell from US87c to US86c and could fall further, he said.

''This reaction struck us as entirely sensible.

''We are forecasting the dollar to average US83c over the remainder of 2014.''

After analysing Mr Wheeler's statement, Mr Stephens said the central bank had made it clear it was now moving into a temporary pause phase.

Westpac expected interest rate markets were going to overreact to the pause signal. The result might be an unintended drop in fixed mortgage rates, Mr Stephens said.

Mr Wheeler said in his OCR review the economy appeared to be adjusting to the monetary policy tightening that had taken place since the start of the year.

It was prudent there now be a period of assessment before interest rates adjusted further towards a more neutral level.

The speed and extent to which the OCR would need to rise would depend on the assessment of the impact of the tightening in monetary policy to date and the implications of future economic and financial data for inflationary pressures, he said.

BusinessNZ chief executive Phil O'Reilly said a period of stability would be positive for the economy.

The Reserve Bank had to balance conflicting pressures in the economy in making yesterday's decision. The change was well signalled and had already been priced in but it ran counter to trends overseas.

''With interest rates in the developed world at near-zero, we need to avoid adding pressure on the New Zealand dollar. It is a balancing act in the face of conflicting pressures.''

The softening in commodity prices on one hand and record net migration on the other made it difficult to chart a course forward, he said.

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