New Zealand's central bank raised its policy rate by another 25 basis points to 3.25 percent, as expected, and signaled further tightening by saying that inflationary pressures are expected to rise so it's important to contain inflation expectations and for interest rates to return to a more neutral level.
The Reserve Bank of New Zealand (RBNZ), which has now raised its Official Cash Rate (OCR) rates three times in a row by a total of 75 basis points, added that "the speed and extent to which the OCR will need to rise will depend on future economic and financial data, and its implications for inflationary pressure."
The RBNZ changed its guidance slightly from April by dropping any reference to the impact of the exchange rate on inflation, largely reiterating the guidance from March that inflationary pressures will determine the pace of its monetary tightening.
In March the RBNZ became the first central bank in the advanced economies to raise rates since July 2011 in order to curb inflationary pressures and ensure that future inflation remains close to the central bank's 2.0 percent target.
New Zealand's headline inflation rate remains moderate, with CPI inflation up only 1.5 percent in the first quarter of 2014, down from 1.6 percent in the fourth quarter of 2013. Wage inflation also remains moderate due to increased labour force participation and strong net immigration.
However, RBNZ Governor Graeme Wheeler, said the above-trend economic growth is absorbing spare capacity and adding pressure to prices in the country's non-tradeables sector.
"These pressures are particularly evident in construction cost increases," Wheeler said, adding that house price inflation also remains high although the housing market has moderated since last year when restrictions on the high loan mortgages were imposed and mortgage rates started rising.
Fiscal consolidation is helping moderate demand, but less than previously assumed, Wheeler said.
In its latest monitor policy statement, the RBNZ projected inflation of 1.7 percent in the June quarter, including non-tradeables inflation of 3.0 percent.
On average, CPI inflation is forecast to rise to an average of 1.5 percent this year from 0.9 percent in 2013, 1.8 percent in 2015 and 2016, and 2.1 percent in 2017.
This is slightly down from the bank's March forecast for 2014 inflation of 1.7 percent, 1.9 percent in 2015, 2.1 percent in 2016, but the same as the forecast for 2017 inflation of 2.1 percent.
The RBNZ also made minor downward revisions to its forecast for the 90-day bank bill, which mirrors the OCR rate.
The central bank affirmed that the bill would rise to 3.3 percent in June but forecast a 3.6 percent rate in September, down from its March forecast of 3.7 percent, but maintained its forecast for a 4.0 percent rate in December.
For 2015, the RBNZ maintained the forecast for the 90-day bill to rise to 4.3 percent in March and 4.5 percent in June, but then revised the forecast down for the bill to hit 4.6 percent in September and 4.7 percent in December, down from the March forecast of 4.7 and 4.8 percent, respectively.
For 2016 the bill is forecast to end the year at 5.2 percent, the same as forecast in March. For 2017 the rate is forecast to remain at 5.2 percent in March, rising to 5.3 percent in June.
On average, the 90-day bill is forecast to rise to 2.7 percent this year, unchanged from March, 3.8 percent in 2015 and 4.7 percent in 2016, also unchanged from March, and 5.1 percent in 2017, down from 5.2 percent forecast in March.
The central bank reiterated that it does not "believe the exchange rate (of the New Zealand dollar)
is sustainable at current levels and it has not yet adjusted to weakening commodity prices, but is expected to do so.
The New Zealand dollar, known as the kiwi, rose rapidly in March 2009 as global investors sought safe haven from the global financier crises, rising from almost 2 to the U.S. dollar to to 1.14 by July 2011. Since then it has been volatile and eased in the middle of last year before gaining strength in the second half as it became clear that the central bank was starting to consider raising rates.
Today the kiwi was quoted at 1.16 to the dollar, up 4.9 percent since the start of 2014.