RBNZ Signals Further Tightening After Third Rate Rise: Economy

New Zealand’s central bank raised interest rates for the third time this year and signaled more tightening to come as the Christchurch rebuild and surging immigration fuel growth, sending the kiwi higher.

“It is important that inflation expectations remain contained and that interest rates return to a more neutral level,” Governor Graeme Wheeler said in Wellington after increasing the official cash rate by a quarter-percentage point to 3.25 percent. The Reserve Bank of New Zealand left its forecast for the 90-day bank bill rate broadly unchanged, suggesting borrowing costs may rise twice more this year.

“The RBNZ is showing very little sign it is about to deviate from the path it laid down in March,” said Nick Tuffley, Auckland-based chief economist at ASB Bank Ltd. “We have brought forward our OCR view, putting a 60 percent chance on a July increase.”

Wheeler is the first central banker from a developed nation to raise official interest rates this year, fueling gains in the nation’s currency. He’s increasing borrowing costs in an election year, with Prime Minister John Key seeking a third term in a poll set for Sept. 20.

The New Zealand dollar climbed as high as 86.52 U.S. cents, the most since May 19, before trading 1.1 percent higher at 86.41 as of 2:08 p.m. in Wellington.

“The bank does not believe the exchange rate is sustainable at current levels,” Wheeler said today. “The exchange rate has not yet adjusted to weakening commodity prices, but is expected to do so.”

Inflation Outlook

The central bank cut its inflation forecasts, giving it scope to pause its policy tightening program in coming months. The RBNZ predicted inflation won’t reach the 2 percent midpoint of its target range until mid-2015, a year later than estimated in March.

Consumer prices will rise 1.7 percent in the current quarter from a year ago, the bank said. That’s less than the 2 percent projected in March. Annual inflation was 1.5 percent in the 12 months through March, slower than the RBNZ estimated three months ago.

Inflation is being curbed by the strong currency and weak prices for some imports, the central bank said. Still, prices of non-tradable goods are rising as economic growth uses up spare capacity, which is particularly evident in construction costs, it said.

Global Stimulus

Wheeler 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 low to spur lending and stoke their own economies. In Australia, central bank Governor Glenn Stevens last week repeated an expectation for “a period of stability” in rates after leaving his benchmark cash rate at a record-low 2.5 percent.

The RBNZ is monitoring recent declines in fixed-term mortgage rates which may boost housing demand. Two-year rates have fallen 15 basis points since the start of the year amid competition between banks and lower global borrowing costs, the bank said.

Wheeler said he would like to see higher longer-term rates.

“It’s an area the RBNZ needs to watch,” Cameron Bagrie, chief economist at ANZ Bank New Zealand Ltd. in Wellington, said in an e-mailed note. “All else equal, lower funding costs and more aggressive competition means the RBNZ needs to do more.”

Yield Outlook

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

A Bloomberg News survey of 15 economists conducted last week showed 13 expected today’s decision; two saw no change.

Wheeler in March indicated the cash rate may rise by 125 basis points to 3.75 percent this year. Economists forecast an increase to 3.5 percent, according to the survey.

New Zealand’s economy “has considerable momentum,” with growth projected to be about 2 percent in the six months through June, Wheeler said. Growth in the second half of 2014 is projected to slow to 1.3 percent, less than the 1.6 percent projected in the RBNZ’s March forecasts.

Recent falls in commodity export prices “will reduce farm incomes over the coming year,” Wheeler said.

Whole milk powder auction prices have fallen 28 percent since a February peak, according to GlobalDairyTrade, which conducts the fortnightly sales. Fonterra Cooperative Group Ltd., the world’s biggest dairy exporter, last month said it expects to pay New Zealand farmers 17 percent less for their milk in the new season.