New Zealand's central bank maintained its benchmark Official Cash Rate (OCR) at 2.5 percent, as expected, but sharpened its recent warning about inflationary pressures and said interest rates had to return to more normal levels and it "expects to start this adjustment soon."
"The Bank remains committed to increasing the OCR as needed to keep future average inflation near the 2 percent target mid-point. The scale and speed of the rise in the OCR will depend on future economic indicators," the Reserve Bank of New Zealand (RBNZ) said in a statement, quoting its governor, Graeme Wheeler.
The RBNZ has been preparing financial markets and investors for higher rates for months. The bank cut its policy rate to the current level in March 2011 but then in July last year warned that it would have to start removing the stimulus. In September the bank said rate rises would likely be needed this year and then in December it said that it "will" raise rates to contain inflation.
New Zealand's headline inflation rate rose to 1.6 percent in December from 1.4 percent in November but the central bank said companies' are increasingly looking to raise prices, and construction costs are increasing and risk feeding into the broader economy.
"While headline inflation has been moderate, inflationary pressures are expected to increase over the next two years. In this environment, there is a need to return interest rates to more-normal levels. The Bank expects to start this adjustment soon," Wheeler said.
One of the central bank's recent concerns has been rising home prices, but Wheeler said there appeared to have been some moderation in the housing market in recent months.
The high exchange rate of the New Zealand dollar - known as the kiwi - has also been dampening inflation but Wheeler said he didn't believe the current exchange rate was sustainable in the long run.
The kiwi started appreciating in March 2009 as investors sought safe haven, rising from almost almost 2 to the U.S. dollar to 1.14 by July 2011. Since then it eased slightly and was largely stable last year around 1.22 to the dollar. But it has been under upward pressure against the yen and recently hit a six-year high of over 87 yen as investors look to take advantage of higher interest rates.
"New Zealand's economic expansion has considerable momentum," Wheeler said, adding that consumer and business confidence was strong.
New Zealand's Gross Domestic Product grew by 1.4 percent in the third quarter from the second for annual growth of 3.5 percent, up from 2.3 percent, and Wheeler expects growth to continue around this level over the coming year.
Improving growth in the global economy should benefit New Zealand's agriculture sector, although Wheeler said export prices are likely to come off their current peaks.
Last month the RBNZ forecast that the 90-day interest rate, which closely tracks the OCR rate, would rise to 3.8 percent by December this year, then to 4.6 percent by December 2015 and to 4.8 percent by March 2016.
Many economists expect the RBNZ to raise rates in March. If it raises rates in March, the RBNZ will become the first central bank in the advanced economies to tighten policy since early 2011.