FINANCE MINISTER THREATENS TO OVERRULE RESERVE

UNCLAS SECTION 01 OF 02 WELLINGTON 000529 SIPDIS SENSITIVE SIPDIS EAP/ANP, EB, INR, PACOM FOR J01E/J2/J233/J5/SJFHQ E.O. 12958: N/A TAGS: ECON EFIN ETRD PGOV PREL AS NZ SUBJECT: FINANCE MINISTER THREATENS TO OVERRULE RESERVE BANK GOVERNOR REF: A) WELLINGTON 452 B) WELLINGTON 365 1) (U) SUMMARY: New Zealand Reserve Bank Governor Alan Bollard is widely expected to increase the official cash rate (OCR) to a new high of 8.25 percent this coming Thursday. Finance Minister Michael Cullen has threatened to override the Bank's legal mandate to raise interest rates that keep inflation under three percent. Cullen's threat has created a political and economic tempest for the Labour government. End Summary 2) (U) New Zealand's economy continues to grow faster than expected, pushing housing prices and inflation upward. To control this expansionary pressure, The New Zealand Reserve Bank (RBNZ),under Governor Alan Bollard, has ratcheted up the Official Cash Rate (OCR) to 8.00 percent, one of the highest levels among OECD countries. This has put exporters under increasing pressure as the 22-year record high Kiwi dollar reached 79.45 US cent mark this past week. One analyst said that the rocketing exchange rate has put the New Zealand economy in a "death spiral." While most analysts offer a more moderate assessment, business leaders, the media, and the political opposition have been loudly attacking the government for failing to bring this problem under control. 3) (U) In open Parliamentary discussion last Wednesday, July 18, Finance Minister and Deputy Prime Minister Michael Cullen mentioned that Section 12 of The Reserve Bank Act (RBA), passed in 1989, did empower the government to override the Bank's requirement to control interest rates for the sole purpose of keeping inflation between one and three percent. His comment came when a member of one of the Labour Government's supporting parties, New Zealand First, raised the possibility of amending the RBA to change the RBNZ's policy targets. The proposed amendment did not have Government support and received criticism from both sides. However, Cullen has maintained since then that Section 12 exists for "a purpose" and broadly hinted that he will invoke Section 12 to prevent a raise in the interest rate if deemed necessary. 4) (SBU) The Reserve Bank Act (RBA),passed in 1989, was one of the most important steps the GNZ took to stabilize its economic and political policy in the wake of what New Zealanders universally regard as the disastrous and highly inflationary political management of the economy in the 1980's. For that reason, commentators have expressed almost horror at Cullen's open discussion of overriding the Act's disciplines through resort to invoking Section 12. This section of the RBA gives the Finance Minister the ability to override the RBNZ's stated policy targets and replace them for a specified period no longer than 12 months. After the end of the specified period the policy targets must be rewritten, but do not have to be the same as the previous targets (i.e., one to three percent inflation range). In this way it functions as a safety value for extreme unforeseen circumstances. 5) (SBU) COMMENT: Prime Minister Clark has stood virtually alone in saying that Cullen's remarks are worth considering. This initiative, even if it is only a feint, shows the increased pressure the Government is feeling from exporters who are getting squeezed by the rising exchange rate (see reftels). At the same time, Cullen most likely is hoping that the mere mention of Section 12 will frighten arbitrageurs enough to sell now, decreasing pressure on the exchange rate. The current rate of return for the NZ dollar and the prospect of even higher returns if the interest rate is increased are simply too attractive for investors to back down because of mere force of posturing. 6) (SBU) If Minister Cullen were to intervene it would surely undermine the independence of the RBNZ and drastically upset confidence in the GNZ's ability to maintain a stable monetary policy. The cost would be too high and could possible induce a hard landing of the Kiwi dollar that the GNZ and the RBNZ want to avoid. Invoking Section 12 is too politically and economically costly to be probable. Some political analysts saw Cullen's willingness to openly discuss Section 12 simply as a mollifying gesture to its political partner the New WELLINGTON 00000529 002 OF 002 Zealand First Party, as one the parties whose support Labour needs to govern. Others see it as just one more indication that Labour is growing increasing desperate trying to improve its weak political standing. End comment. KEEGAN