Alan Bollard

Wellington, June 10 NZPA - Reserve Bank Governor Alan Bollard sees the decision to lift interest rates as a start to the removal of "extraordinary" stimulus from monetary policy.

The Reserve Bank today lifted the official cash rate (OCR) 25 basis points to 2.75 percent, from the record low 2.5 percent in place since the end of April last year.

"The way we see this is we are starting to remove extraordinary stimulus from monetary policy. Further continuation of this is likely," Dr Bollard told Parliament's finance and expenditure select committee.

"We will always make that conditional on what we're actually seeing in economic markets and financial markets."

He expected to be able to go through the removal of stimulus with fewer increases in the OCR than in the last cycle, when the OCR peaked at 8.25 percent.

New Zealand had "good, strong external demand, strong terms of trade, strong export prices," Dr Bollard said.

Rather than going straight into expenditure, the benefits from those factors were going into a rebalancing exercise in the economy.

Business investment was quite constrained, and the recovery in housing was restrained and households were getting rid of debt where they could.

The Reserve Bank calculated 54,000 net jobs were lost during the financial crisis and it expected that to be recovered by some time late this year.

"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," Dr Bollard said when announcing the rise in the OCR.

BNZ head of research Stephen Toplis said it appeared, at face value, that the Reserve Bank intended raising the cash rate 25 basis points in each of its next six meetings taking it to 4.25 percent by March.

It looked as if after that the Reserve Bank intended the odd pause or two on the way to a peak of around 5.75 to 6 percent, Mr Toplis said.

At least in the first instance, the Reserve Bank did not see the rises as being in anyway contractionary, but rather as a reduction in the pressure on the accelerator.

That explained why it had moved and why it would move again, despite the economy remaining in a vulnerable state, Mr Toplis said.

It was important to recognise that times were very volatile and the Reserve Bank would have to be extremely flexible for some time.

ASB economists expect the Reserve Bank to lift the OCR by 25 basis points at each meeting until it gets to 5 percent.

That was lower than the level implied by the Reserve Bank's forecasts of near 6 percent, but was still higher than market pricing for the end point, ASB economist Jane Turner 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 its 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 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.

The bank expects growth in New Zealand of around 3.5 percent this year and next year.

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.