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New Zealand central bank raises rates

New Zealand's central bank raised interest rates on Thursday and signaled further rises through early 2017, taking the lead among developed economies in tightening monetary policy as it tries to quell inflation pressures in an outperforming economy.

In a widely expected move, the Reserve Bank of New Zealand lifted its official cash rate by 25 basis points to 2.75 percent, raising rates from a record low 2.5 percent.

(Read more: New Zealand to go to election on September 20)

"Inflation pressures are increasing and are expected to continue doing so over the next two years," RBNZ Governor Graeme Wheeler said in a statement.

"In this environment it is important that inflation expectations remain contained. To achieve this it is necessary to raise interest rates towards a level at which they are no longer adding to demand."

Mark Coote | Bloomberg| Getty Images

The New Zealand dollar rose around a quarter of a cent to above $0.8500 and interest rate futures fell slightly as the central bank raised its projection for future rate rises in the next two years.

The RBNZ said that it saw considerable momentum in the country's economic expansion, and that growth was becoming more broad-based after being concentrated around earthquake rebuild projects in the Canterbury region.

As a result, the central bank raised its projection for economic growth to 3.5 percent in 2015, from 3.0 percent in its previous statement, before pulling back to 2.3 percent by 2017.

The RBNZ raised its forecast for 90-day bank bill rates through early 2016, and said it expected rates to rise to around 5.25 percent by March 2015.

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RBNZ projections showed the annual consumer price index rising to 2.1 percent in early 2016 and Wheeler said the central bank would raise rates as necessary to keep inflation near its target mid-point around 2 percent.

Wheeler has flagged the tightening for months, arguing higher rates were needed as the economy races ahead on strong commodity prices, the rebuilding of earthquake-hit Christchurch, and strong domestic demand.

Ahead of the RBNZ's decision, financial markets had fully priced in a 25 basis point rate rise on Thursday as well as another 100 basis points of tightening over the next 12 months.

The New Zealand dollar continued to trade at high levels, the central bank said, adding that this remained a headwind to the economy, was unsustainable in the long run, and was expected to gradually moderate in the coming years.

"It's a pretty upbeat statement," said Michael Turner, Strategist, RBC Capital Markets. "Even with the high currency and a slower housing market, they are still confident the rest of the economy is gaining momentum.

Leading the pack

Thursday's rise was the RBNZ's first since July 2010, when it lifted rates to 3.0 percent on signs of recovery from the global financial crisis. But it switched course in March 2011, cutting rates back to 2.5 percent after two major earthquakes in the Canterbury region.

(Read more: Kiwi dollar too strong: New Zealand Finance Minister)

The start of a tightening cycle puts New Zealand well ahead of major central banks in developed economies, who are still grappling with the aftermath of the financial crisis.

The U.S. Federal Reserve is gradually decreasing its massive bond-buying stimulus but remains a long way from raising interest rates, and markets expect the Bank of Japan may have to increase its massive stimulus further to buoy economic growth.

It also takes New Zealand rates above those in neighbouring Australia for the first time in five years, where the Reserve Bank of Australia is expected to keep rates at a record low of 2.5 percent for much of this year as its economy adjusts to the end of a mining investment boom.

The RBNZ raised rates just months after introducing limits to high loan-to-value mortgage lending in October to cool the country's overheated housing market, mainly in two largest cities, Auckland and Christchurch.

House prices have since eased in past months, and the central bank said that the restrictions appeared to be having an faster impact on the market than initially thought.

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