Wheeler gives clear signal OCR is set to rise as economy gathers momentum

Reserve Bank governor Graeme Wheeler says "considerable momentum" in the New Zealand economy means record low interest rates are no longer appropriate in the face of inflation pressures that are "projected to increase."

Wheeler said he will raise the official cash rate from 2.5 percent "as needed in order to keep future average inflation near the 2 percent target midpoint."

The kiwi dollar climbed to 82.62 US cents from 82.37 cents immediately before the Monetary Policy Statement as released and the trade-weighted index gained to 77.47 from 77.25 as investors took today's statement as a more definitive intention to hike interest rates no later than March 2014.

"They are more confident about the breadth of growth in the economy, so even though the currency is higher they are very clear that having very easy monetary policy is becoming even less appropriate," said Mark Brown, fixed interest portfolio manager at Harbour Asset Management.

"They have loaded the gun but they want to have some flexibility around when they would actually go," Brown said. "The market's immediate question will be whether it is January or March, but definitely by March whereas before there had been some argument that they might be later than that."

The momentum in the economic recovery, driven by strong commodity prices, increasing consumer spending and expanding construction is offsetting the impact of a high New Zealand dollar and lower government spending, meaning "it is becoming unnecessary to maintain the current degree of monetary stimulus," the bank said in the monetary policy statement.

"The bank's assessment is that, consistent with CPI inflation settling near the 2 percent midpoint of the target range over the medium term, growing demand and inflation pressure should warrant a withdrawal of stimulus beginning in 2014," it said.

The central bank lifted its forecast track for the 90-day bank bill rate, seen as a proxy for the OCR, by 10 basis points through the projected period, with the rate predicted to increase to 2.7 percent in the March quarter of next year, rising to 3.8 percent by the end of the year, and 4.8 percent by March 2016.

The higher track for the rate was on the view that terms of trade, which reached a 40-year high in the September quarter, and domestic demand were stronger than previously thought, despite a higher currency than projected.

Wheeler has previously indicated he plans to raise rates next year depending on how much the bubbling housing market and growing building activity spill over into lifting inflation, though the pace and scale of tightening may depend on the strength of the currency.

"The RBNZ's Monetary Policy Statement this morning was slightly hawkish compared to market expectations," said Imre Speizer, market strategist at Westpac Banking Corp.

Yesterday, traders were betting Wheeler will lift the key rate 116 basis points over the coming year, according to the Overnight Index Swap curve.

Wheeler today said the forecast track suggests the rate will rise 2.25 percentage points over the coming two-and-a-quarter years.

The bank increased its forecast for the annual pace of inflation through the first half of 2014, though sees a slower pace from the September quarter than previously thought as measures of underlying inflation show it's beginning to pick up.

Wheeler singled out the strong kiwi dollar as offsetting domestic demand, saying "the high exchange rate is a particular headwind for the tradables sector and the bank does not believe it is sustainable in the long run."

Still, the Reserve Bank expects the currency will remain at a high level by past standards, even if it moderates over the medium term.

The currency has been trading above the central bank's September projections since the Federal Reserve's decision to keep printing money at its current pace left the greenback debased, and as Australia's slowing economy pushed the kiwi to five-year highs against its trans-Tasman counterpart. The accelerating local economic recovery and terms of trade at a 40-year high have added to investor's appetite for the kiwi.

The currency traded at 77.56 at 5pm in Wellington yesterday, above the 74.3 quarterly average projected by the Reserve Bank, a level it hasn't tested since early September.

As a means to clamp down on riskier lending fanning the flames in a heating property market, Wheeler imposed restrictions on the level of low-equity lending banks can write to help stifle demand without having to resort to an interest rate hike. Quotable Value figures this week showed property prices rose at an annual pace of 9.2 percent last month.

The bank estimates the restrictions will lower annual house price inflation by between 1 and 4 percentage points, and trim household credit growth by between 1 and 3 percentage points.

Wheeler said the bank is watching the housing market closely, though data to assess the impact of the loan restrictions is limited to date.

While the policy has only been in place since October, the bank this week carved out new housing from the policy after it was convinced that high loan-to-value lending on new builds financed about 12 percent of activity, but just 1 percent of total mortgage lending.

(BusinessDesk)