The New Zealand dollar jumped about half a cent after the Reserve Bank signalled steeper rate hikes are likely next year, increasing the country's yield advantage for international investors.
The kiwi rose as high as 81.35 US cents, from 80.80 cents immediately before the statement was released at 9am. The currency recently traded at 81.23 cents.
Reserve Bank governor Graeme Wheeler kept the benchmark rate at 2.5 per cent for now, but signalled expected rate hikes next year will likely be steeper than previously anticipated as the housing market and construction sector continue to gather momentum.
"A strong economy brings with it higher levels of interest rates and that is in an environment where the rest of the world isn't going to be raising interest rates any time soon," said Fergus McDonald, who helps manage about $2.3 billion of New Zealand fixed income assets at Tyndall Investment Management. "New Zealand starts to stand out as an economy which is performing well and it will also have a widening interest rate differential between us and the rest of the world."
The central bank ramped up its forecast for increases to the 90-day bank bill rate, often seen as a proxy for the official cash rate, with a sharper lift in the middle of next year. The bank sees the rate rising to 3 per cent in the June quarter and 3.6 per cent by the end of 2014, before steadily increasing to 4.2 per cent by March 2016. It had previously predicted the rate would be at 3.2 per cent by the end of 2014, rising to 4.2 per cent in early 2016.
The higher projection was due to stronger-than-expected net migration and export commodity prices, and the recent depreciation in the New Zealand dollar, the bank said in its September monetary policy statement.
Traders are pricing in about 89 basis points of hikes over the next year, according to the overnight index swap curve.
Wheeler held his current view that the benchmark interest rate will probably stay on hold for the rest of the year, while trying to talk the currency down, saying it was still high despite the recent decline.
"A lower rate would reduce headwinds for the tradables sector and support export industries," Wheeler said.
The central bank is using restrictions on low equity home lending in an attempt to quell rising house prices because it is conscious that early rate rises would likely push up the currency, said Tyndall's McDonald.
The restrictions, which come into force next month, will be seen as having the same impact as one tightening, with the more conventional rate hike likely to follow in March, McDonald said.