Is this Wheeler's final, final intervention warning?

The real effective exchange rate chart used in Wheeler's statement

Reserve Bank Governor Graeme Wheeler took the unusual step on Thursday afternoon of issuing a full statement titled "New Zealand's Exchange Rate: Why the Reserve Bank believes its level is unjustified and unsustainable."

The New Zealand dollar dropped more than one USc to 79.3 USc after the release of the statement, which was interpreted as at least a warning, if not a pre-justification, for intervention to push the currency lower. Wheeler spelled out at length what he meant by 'unjustified and unsustainable', which are two of the bank's code words or 'traffic lights' to justify intervention.

The statement was unusual in that it was issued just two weeks after a full Monetary Policy Statement, which would be one of the usual venues for such a warning, although the MPS' placement nine days before an election may have complicated matters. Wheeler declined direct comment on intervention in the September 11 news conference. Thursday's statement was published in the speech section of the Reserve Bank's website and was 2,290 words long, but was not flagged as a speech to the market, surprising many when it was released.

Wheeler used a chart (reproduced above) showing the real effective exchange rate being around 25% above its average since 1964.

"Even allowing for New Zealand’s economic out-performance relative to most advanced economies, New Zealand’s real effective exchange rate is above the level that can be justified," Wheeler said.

"In particular, the real exchange rate has not adjusted materially to the recent downward movement in commodity prices - the factor that normally best explains movements in the real exchange rate," he said.

Wheeler pointed out the real effective exchange rate had actually risen 1% since February, while dairy prices had fallen 45% over the same time.

"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," he said.

Wheeler added that the IMF had estimated in May that the currency was 5-15% over-valued, while the Peterson Institute had estimated in May it was 15% above its sustainable level and the highest of all 34 currencies reviewed.

"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 having an impact on the exchange rate," Wheeler.

Here's my backgrounder from March on why the Reserve Bank was not intervening, and how its 'traffic lights' system for intervention works. The currency must be at 'extreme' and 'unsustainable' levels, and the Reserve Bank must be able to intervene in a way that catches the market offguard at an 'opportune' moment. Any intervention must also not clash with the bank's monetary policy moves.

'Ready to slump 11%?'

Wheeler also pointed to a table showing previous episodes of New Zealand dollar depreciation in the post-float era, including that the average decline in the first year was 11%.

He then laid out what factors could drive a large slump, including slowdowns in New Zealand and China, a pickup in US growth or some sort of geo-political shock.

"In the Reserve Bank’s view, the combination of these factors makes the New Zealand dollar susceptible to a significant downward adjustment over the coming six to nine months."

The specificity of Wheeler's warning about the size of a fall and the time frame surprised a few economists.

Financial markets are now on heightened alert for intervention, including the bank's monthly announcement of its own foreign assets and liabilities on Monday at 3pm, which would show whether it has been intervening in a passive way. The last time the Reserve Bank intervened in a major way in 2007/08, it issued a statement declaring the intervention.

However, Wheeler reiterated that the Reserve Bank still expected to keep raising after its current pause to assess how the first 100 basis points of hikes affected the economy.

He also made no mention of the final 'traffic light' in the system, which is that any intervention must not conflict with monetary policy. Any slump in the New Zealand dollar would be inflationary, which would conflict with the bank's current tightening cycle, although some might argue it's current 'pause' gives it some wiggle room.

Wheeler's latest jawboning is also not his first warning about a high New Zealand dollar. He has warned about the high currency 13 times since October 2012, using a variety of phrases ranging from "high", "not sustainable", "unjustified", "overvalued" and that it was a "headwind."

13 warnings in 2 years

He said in October 2012 the high New Zealand dollar was undermining exports. He described it as a headwind in December 2012. It was "not sustainable in the long run" in January 2013 and was "overvalued" in March 2013. By April it was "overvalued and a headwind." It was still "overvalued and a headwind" in June and July, and was "high" and a "headwind" in September and October last year. By April this year it was "high, a headwind and not sustainable."

By June this year it was "not sustainable at current levels." Wheeler ramped up his warning in July by saying the New Zealand dollar was "unjustified, unsustainable and and had the potential for a significant fall." On September 11, he said it was currently unjustified and unsustainable and significant depreciation could be expected.

The depth of explanation and strength of view in this latest statement suggests a type of final warning. If the currency does not fall unassisted and the Reserve Bank does not intervene, then the power of the Reserve Bank's warnings will start to depreciate.