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Higher interest rates, a rising dollar and the prospect of more foreign investment into New Zealand markets are likely to follow a hawkish review of the economy by the Reserve Bank.
Reserve Bank governor Graeme Wheeler lifted the official cash rate by 0.25% to 3.25%, as expected. What was not expected was the tone of his remarks which indicated a further rise in interest rates next month, instead of the long break he was expected to take.
The dollar rose 0.5% against the Australian, Europe, British and United States currencies after the announcement.
Craigs Investment Partners broker Chris Timms said Mr Wheeler gave no indication of a pause in the rate rises, catching markets by surprise.
Asked if retail banks were caught out after dropping fixed lending rates recently, Mr Timms said the interest rate curve recently had shown rising short-term interest rates and falling longer-term rates.
Mr Wheeler's statement yesterday changed that immediately.
''It is fair to say some banks have been caught out.''
The governor pointed to a strongly growing economy, while acknowledging some prices for New Zealand's exports, particularly dairy products, were falling.
As interest rates rose in New Zealand, overseas investors would start looking for better returns than those being received in Europe, where the European Central Bank had introduced negative interest rates, the first major central bank to do so, Mr Timms said. That would keep upward pressure on the dollar.
BusinessNZ chief executive Phil O'Reilly said the needs of exporters must be factored in to any additional OCR rises this year.
The rise in the exchange rate following the announcement was not what the economy needed.
''The Reserve Bank clearly expects the exchange rate to fall, given weaker international dairy prices. But exporters would nevertheless invite caution.''
There was still potential for New Zealand's economic growth to slow, despite the current enviable rate of expansion. Inflationary pressures were not widespread in the economy, he said.
Current inflationary pressures often stemmed from central and local government-imposed regulation.
''In this environment, the Reserve Bank should pay heed to the needs of New Zealand exporters and the productive sector when thinking and deciding upon further rate rises,'' Mr O'Reilly said.
BNZ market economist Stephen Toplis said the Reserve Bank appeared to have a July rise firmly in its sights, followed by a pause in September then a further increase in October or December.
''There is very clear evidence in both the data in the Monetary Policy Statement and the Reserve Bank's rhetoric it wants to get the cash rate up to 3.5% as soon as possible. Hence, our maintained call for July.''
There was no indication anywhere a near-term pause was being contemplated, he said.
It was likely the Reserve Bank would pause for the election to give it time to rethink the overall strategy.
Before the next OCR review, first quarter GDP (economic growth) would be published on June 19. The Reserve Bank had increased its forecast to 1.1%, in line with most forecasts.
On July 16, second-quarter inflation would be published. The Reserve Bank was picking 0.3% to give inflation of 1.7% for the year.
The BNZ was forecasting quarterly inflation of 0.5% and 1.9% annually.
Mr Toplis said there was nothing seen yesterday to change his view the tightening cycle had a long way to run before it ended.
''July will be the next step along the way, September a pause and the track from thereon will be highly data-dependent, with the currency the variable of most interest to us.''
Mr Wheeler said while house price inflation remained high, the housing market had moderated since late last year when restrictions were applied to high loan-to-value ratio mortgage lending and when mortgage interest rates started rising.
Inflationary pressures were expected to increase.
''It is important inflation expectations remain contained and interest rates return to a more neutral level. 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 pressures.''
At a glance
- Economic growth 4% for the year ended June
- OCR likely to peak at 5% next year
- Concern from exporters about strength of dollar
- Inflation expected to increase