N.Z. Raises Key Rate to Become First Developed Nation to Tighten

New Zealand raised its key interest rate, the first developed nation to exit record-low borrowing costs this year, and said it plans to remove stimulus faster than previously forecast to contain inflation.

“It is necessary to raise interest rates toward a level at which they are no longer adding to demand,” Reserve Bank of New Zealand Governor Graeme Wheeler said in a statement in Wellington after increasing the official cash rate by a quarter percentage point to 2.75 percent, as forecast by all 15 economists in a Bloomberg News survey. The Kiwi gained after Wheeler said further increases are likely in coming months and the OCR may rise by a total of 125 basis points this year.

Soaring dairy prices, the NZ$40 billion ($34 billion) rebuild of earthquake-damaged Christchurch and the strongest immigration in 10 years are fueling growth in the South Pacific economy. Wheeler is departing from global peers as surging house prices in the nation’s biggest city of Auckland stoke concerns of a bubble and add to inflationary pressures.

“We’re on a different planet,” Stephen Toplis, head of research at Bank of New Zealand Ltd. in Wellington, said in an interview. “New Zealand’s environment is fundamentally different to most of our peers” because of record-high commodity prices and construction, he said.

Forecasts Raised

The RBNZ today lifted its forecast for the 90-day bank bill rate, suggesting borrowing costs will rise more quickly than previously expected. The tightening is set to come in an election year, with Prime Minister John Key seeking a third term in a poll set this week for Sept. 20.

Wheeler will raise rates at his next two opportunities in April and June then pause until December, according to the median forecast in a Bloomberg News survey of 15 economists conducted after today’s decision. Six analysts expect a rise at the Sept. 11 review.

“If the economic environment makes it a pre-requisite, then he’ll go, but any central bank governor would prefer to not get involved in the election,” said Toplis.

New Zealand’s dollar rose to its highest since May 1 after the RBNZ decision. It bought 85.59 U.S. cents at 5:36 p.m. in Wellington, up from 84.65 cents immediately before the statement.

“The bank does not believe the current level of the exchange rate is sustainable in the long run,” Wheeler said, reiterating that the currency’s strength is a “headwind” for exporters and local manufacturers who compete against imports.

Faster Inflation

The central bank today raised its forecasts for inflation, predicting it will reach the 2 percent midpoint of its target range 18 months sooner than estimated in December.

“With inflation now rising and inflationary pressures building, there is a need to return interest rates to more-normal levels,” the bank said in its Monetary Policy Statement. “The speed and extent to which the cash rate will be raised will depend on economic data and our continuing assessment of emerging inflationary pressures.”

New Zealand is removing monetary stimulus at the same time as the Federal Reserve, the European Central Bank, the Bank of England and the Bank of Japan pledge to hold interest rates at record lows to spur lending and stoke their own economies.

The RBNZ expects to raise the key rate by about 2 percentage points over two years, with the pace depending on economic data, Wheeler said.

“The RBNZ appears more likely to front-load the increases into 2014,” said Nick Tuffley, Auckland-based chief economist at ASB Bank Ltd. “A combination of greater inflation pressure and strict adherence to the 2 percent midpoint have prompted us to revise up our OCR view.”

ASB now expects OCR increases in April, July and December, and four further hikes over 2015 to a peak of 4.5 percent.

Bill Yield

The RBNZ forecast that the three-month bank bill yield will be 4 percent by the end of 2014, up from the 3.8 percent it forecast three months ago. The outlook is seen as a guide to the direction of the cash rate.

The RBNZ is responding to a build-up in inflation pressures even as a strong currency holds down the prices of imports, Wheeler said. Annual inflation accelerated to 1.6 percent in the fourth quarter, the fastest in almost two years and more than the central bank projected on Dec. 12.

The bank expects inflation will accelerate to 2 percent by mid-2014, up from 1.6 percent previously, and to remain near that level for the next three years, according to fresh forecasts published today. Wheeler focuses on achieving average annual inflation of 2 percent, the midpoint of the bank’s 1 percent to 3 percent target.

Economic Growth

Gross domestic product will expand 3.3 percent in the year ending March 31, faster than the 2.7 percent pace projected in December, the RBNZ said today. The economy will grow 3.2 percent in the year through March 2015, it said.

“New Zealand’s economic expansion has considerable momentum,” Wheeler said. “The extended period of low interest rates and continued strong growth in construction sector activity have supported recovery.”

A gauge of business confidence climbed in February to the highest in almost 20 years, ANZ Bank New Zealand Ltd said last month. Permanent immigration in January was the highest since May 2003, according to a Feb. 27 government report.

House prices jumped 8.2 percent in February from a year earlier, the Real Estate Institute said this week. The pace has slowed from 9.9 percent in the year through October after Wheeler introduced restrictions on low-deposit lending. Still, prices in Auckland, home to about a third of New Zealand’s 4.4 million people, surged 16.9 percent from February last year.

“Restrictions on high loan-to-value ratio mortgage lending are starting to ease pressure and rising interest rates will have a further moderating influence,” said Wheeler.

Global Growth

The International Monetary Fund in January raised its forecast for global growth this year as expansions in the U.S. and U.K. accelerate. The Fed has begun to reduce the size of its bond-purchase program as the U.S. jobless rate declines. China, which is New Zealand’s biggest export customer, this month said it is targeting 7.5 percent growth.

Growth is gradually increasing in New Zealand’s trading partners while global financial conditions continue to be very accommodating, Wheeler said.

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