New Zealand raises key rate but not done yet

Fall in the dollar may push rise even higher as central bank looks to contain inflation pressure

PUBLISHED : Thursday, 12 June, 2014, 3:41pm
UPDATED : Friday, 13 June, 2014, 5:40am

New Zealand's central bank sees the neutral level for its cash rate possibly as high as 5 per cent, deputy governor Grant Spencer said, indicating the bank might need to raise rates more if the local currency were to fall markedly.

The Reserve Bank of New Zealand, as expected, raised its official cash rate by 0.25 percentage point to 3.25 per cent yesterday, the third rise in as many meetings, as it looks to contain inflation pressures in the economy.

The monetary statement cooled expectations that the bank would possibly signal a pause in its tightening because of a strong exchange rate and recent data showing modest inflation.

"Our forecasts and our modelling say we need to move back to a neutral rate, and that's north of where we are now," Spencer said.

He said neutral was 4.5 per cent to 5 per cent, and that the bank would be pre-emptive in managing inflation risks.

Still, there were many uncertainties that would influence policy, Spencer said.

"We have to feel our way as we tighten … [but] we always try to be on the front foot ahead of the curve," he said.

The central bank estimates the economy has grown about 4 per cent in the year to June, as post-earthquake reconstruction in the Canterbury region, a booming housing market, high terms of trade and increasing migration drive growth.

The Reserve Bank's forecast of wholesale interest rates, taken as a barometer for its tightening bias, implied two more 0.25 percentage point rises this year and three more next year, taking the cash rate to 4.5 per cent by the end of next year.

Spencer said added pressure to raise rates would come from a marked fall in the exchange rate, which could follow an end to the loose money policies of large developed economies, particularly the United States.

"The main benefit for us is that would strengthen the US dollar, which would weaken the New Zealand dollar against the US and put our policy more in sync with global policy," he said.

"It would have some inflationary pressure, but we'd be happy to see that."

Markets have priced in a 52 per cent chance of a rate rise next month and a further 0.8 percentage point of tightening over the next 12 months.