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New Zealand's Central Bank Lifts Interest Rates, Currency Surges

New Zealand's central bank raised interest rates on Thursday by a quarter of a point to 8%, the highest among industrialized countries, saying it was worried robust consumer demand would further fuel inflation.

The New Zealand dollar jumped to a 22-year high after the announcement, which came as a surprise to most economists, who had expected the Reserve Bank of New Zealand to keep its official cash rate on hold after raising it at its previous two reviews.

"They're doing what they've to got to do. There's an urgency to slow the economy down and they're starting to wake up to that," said Bank of New Zealand senior economist Craig Ebert.

In the latest Reuters poll, 12 of the 16 analysts had forecast rates would be left unchanged. The median risk of a 25-basis-point rise was put at 35%.

The New Zealand dollar jumped around half a cent to $0.7566, the highest level since it floated in March 1985.

Bank bills were sold off, with the yield on a September contract rising 11 basis points to 8.39%. Short-term bond yields rose around five basis points.

As in its April statement, the central bank did not give any policy outlook, but its key bank bill forecast suggested another rate increase was possible.

A further rise in interest rates will add to the New Zealand dollar's yield attraction but Governor Alan Bollard warned that the currency was already at an exceptional and unjustifiable level.

"As we noted in April, the exchange rate is at levels that are both exceptionally high and unjustified on the basis of New Zealand's medium-term fundamentals," he said.

The RBNZ is worried that currency strength will hurt the export sector and cause the country's large current account deficit to deteriorate further.

Annual inflation eased to 2.5% in the first quarter, holding below the upper end of the central bank's 1-3% target range, but a key measure of underlying inflation has remained near 4%.

Retail sales volume soared at a record pace in the first quarter as consumers stepped up spending on cars and appliances.

The housing market has shown little sign of cooling, with median house prices rising nearly 15% in the year to April, data from the Real Estate Institute of New Zealand showed.

Bollard also warned that a significant increase in the payout to dairy farmers next season, and the government's budget for 2007/08, both announced in May, were also adding to inflation pressures.

Finance Minister Michael Cullen has said the budget was not designed to add to domestic demand, but it included a cut in business taxes and tax benefits related to a new workplace savings scheme.