But when interest rates are simply increased in response to a weak exchange rate, in the absence of inflationary pressure, financial markets recognise that higher interest rates are likely to be a temporary phenomenon, followed by lower interest rates.
In this situation, not only may an increase in interest rates not help to support the exchange rate, it may actually cause a further decline in the exchange rate. Thirdly, the Reserve Bank could intervene directly in the foreign exchange market, by buying New Zealand dollars with some of the foreign exchange reserves which we currently hold.