The Reserve Bank has edged its key interest rate up, after holding it at a record low for 13 months to fight the impacts of the global financial crisis.
In lifting the official cash rate (OCR) 25 basis points today to 2.75 percent, from the 2.5 percent in place since the end of April last year, the Reserve Bank said expected robust growth was likely to see underlying inflationary pressures increase.
As such, given the current low level of the OCR, it was appropriate to gradually remove policy stimulus.
Reserve Bank Governor Alan Bollard said the further removal of stimulus would be reviewed in light of economic and financial market developments.
"The fact that bank funding costs are higher, long term interest rates are higher than short term interest rates, and a greater proportion of borrowers use floating rate mortgages should all reduce the extent to which the OCR will need to be increased relative to previous cycles," he said.
The Reserve Bank expects headline annual consumers price index (CPI) inflation to rise to 5.3 percent in the June quarter of 2011, boosted by higher GST, higher tobacco excise taxes, and the increases to the price of fuel and electricity from the emissions trading scheme.
That is well above the band of 1 to 3 percent which is the Reserve Bank's target for CPI growth on average over the medium term.
The extent to which the OCR was increased in reaction to the Government policy increases would be governed by the extent to which inflation expectations and wage claims were affected, the Reserve Bank said in its Monetary Policy Statement (MPS) published today.
Reductions to personal tax rates more than offset the effects of the GST rise, which was therefore assumed to have no effect on wage bargaining. Rises in other indirect taxes were assumed to have only a limited impact on inflation expectations.
In 2012, annual CPI growth is projected to be slightly above 2.5 percent.
So far this year, an 11 percent rise in petrol prices had been offset by relatively favourable climatic conditions keeping down fruit and vegetable prices, which were now 5 percent lower than a year ago, the MPS said.
Retailers were also passing through discounts on durable consumer goods, from the appreciation of the NZ dollar towards the end of 2009.
A weak housing market had led to rents rising very little, while construction cost inflation had also been very low although builders' pricing intentions suggested a strong rebound in the near future.
Dr Bollard pointed out that growth in trading partner activity was continuing, and against that backdrop this country's commodity prices had risen sharply in the past few months.
New Zealand was expected to have growth of around 3.5 percent this year and next year, Dr Bollard said.
The main impact on this country of the renewed turmoil that had hit financial markets was expected to come through continuing upward pressure on the cost of funds to the banking system.
But the MPS noted "substantial downside risk" to the projection for continuing robust growth connected to high sovereign debt problems in the euro area.
Concern around the exposure of US and European banks to euro-area sovereign debt had increased pressures in global funding markets, the MPS said.
"Consequently, there is now some risk that ongoing disruption in these markets will have a material effect on the cost and availability of credit for many countries, including New Zealand."
