UPDATE 2-NZ central bank raises rates, quells talk of slower hikes

Wed Jun 11, 2014 10:11pm EDT

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By Gyles Beckford

WELLINGTON, June 12 (Reuters) - New Zealand's central bank raised interest rates to a five-year high on Thursday and cooled expectations it may slow the pace of future policy tightening, sending the currency sharply higher.

As expected, the Reserve Bank of New Zealand lifted its official rate by 25 basis points to 3.25 percent - the highest level since January 2009 and the third consecutive rise in as many meetings.

The central bank said rates would need to go higher as strong economic growth fuels inflation pressures, making it the only central bank among developed economies to be raising rates in the current cycle.

"In this environment, it is important that inflation expectations remain contained and that interest rates return to a more neutral level," RBNZ Governor Graeme Wheeler said in a statement.

The hawkish tone of the statement and the governor's determination to rein in growing price pressures wrong-footed markets which had expected the bank to signal a slightly slower pace of tightening.

The New Zealand dollar, its yield appeal burnished by the RBNZ's tough talk, soared half a cent to settle around $0.8635, while interest rate futures <0#NBB:> edged lower.

"It (statement) was a lot more hawkish than the market was expecting. The market had underpriced the 90-day track further out and the RBNZ has maintained the same path, so that's the reason why the kiwi is stronger," said Tim Kelleher, head of institutional FX sales at ASB.

The central bank's statement and forecasts were little changed from those in March and April, reiterating that inflation pressures are building, particularly in the construction sector, and that terms of trade and migration gains were underpinning growth, although the high exchange rate was offsetting.

Annual inflation slowed fractionally to 1.5 percent in the first quarter, and the RBNZ wants to anchor it around 2 percent, the mid-point of its 1-3 percent target band.

The central bank gave few signs it is preparing to ease up in its battle to control inflation.

"The speed and extent to which the OCR (official cash rate) will need to rise will depend on the future economic and financial data, and its implications for inflationary pressures," Wheeler said.

Some in the markets had expected a slight softening in the tightening bias in the wake of a strong currency, falling commodity prices and signs of a slowdown in housing inflation.

A Reuters poll after the decision has a clear expectation of a further 25-basis-point rise in July and one more this year, most likely in December.

Market pricing after the statement implied a 52 percent chance of a rate rise in July and 80 basis points of hikes in the next 12 months, compared to 96 basis points before Thursday's decision.

"This tightening cycle has a long way to run before it's all over and done with," said Bank of New Zealand head of market research Stephen Toplis.

BOOMING ECONOMY

The RBNZ's forecasts of wholesale interest rates implied two further 25 basis point rate increases this year, and a steady pace through 2015, largely unchanged from its March projections.

The bank has previously said it expects to raise rates by about 200 basis points through to late 2015 as post-earthquake reconstruction in the Canterbury region, a booming housing market, high terms of trade, and increasing migration drive the economy.

The RBNZ said it estimated the economy has grown about 4 percent in the year to June, although it trimmed its forecast slightly for future years. It also reduced inflation forecasts a shade.

The bank repeated its familiar comment that the New Zealand dollar remained unsustainably high despite the sharp fall in commodity prices, but the Governor shied away from saying conditions were appropriate for it to sell the currency.

The RBNZ said it was factoring in further softness in commodity prices and a lower exchange rate.

Analysts said the RBNZ seemed intent on not giving the impression it is easing up on tackling inflation.

"They still want to get rates to a more neutral levels and that's a clear reaffirmation of their tightening bias," said Michael Turner, a strategist at RBC Capital Markets.

Turner said it remained an open question as to what neutral interest rates might be. "There's a suggestion it might be around 5 percent, but that seems very high in this low-rates world."

The RBNZ said major world economies looked to be recovering albeit at a modest pace, and it expected global inflation pressures and stimulatory policies to stay in place for some time. (Editing by Lincoln Feast & Shri Navaratnam)

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