Wheeler lifts OCR to 2.75 percent in first hike since 2010, signals steeper rate track

Reserve Bank governor Graeme Wheeler lifted the official cash rate a quarter-point to 2.75 percent in the first move of a tightening cycle, and signalled potential for a steeper track for future hikes as he tries to prevent inflation accelerating.

"While headline inflation has been moderate, inflationary pressures are increasing and are expected to continue doing so over the next two years," Wheeler said in a statement. "The speed and extent to which the OCR will be raised will depend on economic data and our continuing assessment of emerging inflationary pressures."

The Reserve Bank sees a faster pace of inflation than in its December forecast, with the consumers price index rising to 2 percent as soon as the June quarter, a level the bank had previously expected in mid-2015. While a strong currency will keep a lid on imported inflation, the bank expects non-tradable inflation to increase to about 4 percent.

The monetary policy statement said the bank expects "the OCR will need to rise by about 2 percentage points over the next two years for inflation to settle around the target," depending on the economic outlook.

"By increasing the OCR as needed to keep future average inflation near the 2 percent target mid-point, the bank is seeking to ensure that the economic expansion can be sustained," Wheeler said. He's tasked with keeping CPI between a range of 1 and 3 percent, with a target to keep inflation near the mid-point.

The central bank raised its forecast track for the 90-day bank bill rate, seen as a proxy for the OCR, by about 20 basis points from the June quarter this year, and sees the rate rising to 4 percent by the end of 2014 and 5.3 percent by March 2017. It had previously seen the rate increasing to 3.8 percent by the end of 2014, and 4.8 percent by March 2016. Yesterday, traders were betting Wheeler will lift the OCR 134 basis points over the coming 12 months, according to the Overnight Index Swap curve.

"While the RBNZ's projected path of interest rate hikes could still reasonably be described as 'gradual' compared to past tightening cycles, it won't leave much room for dallying - consecutive hikes at some stage are a given, and in our view are more likely to occur up front," Imre Speizer, market strategist at Westpac Banking Corp, said in a note before the release.

Today's hike had been fully-priced in by the market after the central bank signalled rates needed to rise as the local economy gathers momentum. Wheeler had previously been reluctant to lift the key rate because of the strength of the currency, which yesterday reached a new post-float high 79.68 on a trade-weighted basis.

The trade-weighted index was an average 78.18 in the March quarter, higher than the Reserve Bank's December projection of 77.4. The bank now sees the New Zealand dollar remaining elevated for a longer period of time, with the TWI staying above 77 until the end of 2016.

"The high exchange rate remains a headwind to the tradables sector," Wheeler said. "The bank does not believe the current level of the exchange rate is sustainable in the long run."

The kiwi fell as low as 84.37 US cents before recovering to trade at 85 cents, from 84.73 cents just before the statement was released.

Wheeler said local economic growth has considerable momentum, underpinned by strong export commodity prices and construction activity, and is becoming more broad-based.

Growth has been buoyed by insatiable Chinese demand for New Zealand dairy products, making the world's most populous nation the nation's biggest trading partner, and keeping the terms of trade at a 40-year high.

The bank expects gross domestic product grew at a 3.3 percent pace in the year ending March 31, and forecasts growth of 3.2 percent the following year, up from a previous forecast of 2.7 percent. Growth is forecast to moderate to 2.2 percent in the years to March 2016 and 2017.

The Reserve Bank has held the OCR at a record low 2.5 percent since March 2011, a move similar to most of the world's major central banks seeking to stimulate economic growth after the global financial crisis froze credit markets.

That's largely ended as the US Federal Reserve notes a stronger American economy and sounder financial system, and has hinted at further winding back its bond buying programme. New Zealand is leading the pack, widening the interest rate gap with other developed economies, as the nation benefits from booming demand for its soft commodities, a pickup in home building, and increasingly confident businesses and consumers.