January 31, 2014 / 12:45 AM / 4 years ago

UPDATE 1-New Zealand rate rise needed soon - RBNZ governor

* Inflation pressures seen growing over next two years

* NZ houses overvalued, unlikely to fall much; LVR limits have impact

* NZ dlr considerable headwind, unsustainable long term (Adds quotes, detail, market reaction)

CHRISTCHURCH, New Zealand, Jan 31 (Reuters) - New Zealand’s central bank said on Friday that interest rates must rise as soon as March to counter rising inflation pressure from high commodity prices and strong housing and building markets.

“In this environment, there is a need to return interest rates to more normal levels and the Bank expects to start this adjustment soon,” Reserve Bank of New Zealand Governor Graeme Wheeler told a business group in Christchurch.

His remarks repeated comments made on Thursday when the RBNZ held its official cash rate at a record low 2.5 percent, the level it has been at for nearly three years.

Wheeler repeated his view that the strong New Zealand dollar was a “considerable headwind” for the economy, and not sustainable at current levels in the long run.

The New Zealand dollar, buoyed in recent months by the prospect of higher interest rates, fell following his remarks, dipping to a low around $0.8147 from $0.8178.

Wheeler said the speed and size of rate rises would be influenced by many factors, including the terms of trade, which are at 40 year highs, the high exchange rate, and price pressures from the building and housing sectors.

“Although headline inflation has been moderate, inflationary pressures are expected to increase over the next two years,” Wheeler said, adding the bank aimed at keeping inflation near the 2 percent midpoint of its target range.

Most economists anticipate the New Zealand tightening cycle will begin in March, after a string of strong data showed the $170 billion economy growing faster than the RBNZ’s forecast, while inflation was approaching its 2 percent target.

A Reuters poll taken after the decision found 16 of 17 economists seeing a rate rise in March.

Wheeler said inflation pressures were an important risk to New Zealand’s continued expansion, and a rise in interest rates was needed to contain them.

He noted, however, that restrictions on low-deposit home loans last year appeared to be moderating turnover and prices, although household debt levels were rising again.

Housing was overvalued but a substantial fall in prices was seen as unlikely.

Wheeler said offshore threats to New Zealand’s expansion included a faltering in the recovery in the euro zone, and a rapid build up of debt in China, now New Zealand’s top export market.

New Zealand’s terms of trade could be expected to come off their highs, and the current account deficit could be expected to deteriorate - but not enough to provoke a severe reaction.

Reporting by Gyles Beckford in Wellington and Naomi Tajitsu in Christchurch; Editing by Paul Tait and Eric Meijer

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