The Reserve Bank has put borrowers on notice, pencilling in a full percentage point of interest rate rises next year and as much again in 2016.
The projected interest rate track in the September monetary policy statement it released yesterday is about 50 basis points higher than three months ago, but still 50 basis points less aggressive than the financial markets have priced in.
And its best guess is that rates would be another 30 basis points higher still without the restrictions on low deposit home loans it introduced last month.
Although that policy is primarily intended to bolster the banking system against the risk of a sharp correction in house prices, the Reserve Bank estimates it will shave 2.5 percentage points off house price inflation and reduce the spillover from rising house prices into general inflation seen in previous housing booms.
It expects the annual rate of house price inflation to hit 10 per cent over the next six months but then taper off to around 4 per cent by the end of next year.
When challenged about the impact of the policy on first-home buyers, governor Graeme Wheeler said his thinking was influenced by the fact that he was living in the United States after the global financial crisis.
US median household wealth fell 39 per cent and one in every four households with a mortgage had negative equity.
"That number has gone down quite slowly," he said. "It creates enormous human distress, as well as the effect on economic output."
Housing is significantly over-valued in New Zealand, he said, pointing to Auckland where house prices are 22 per cent above their previous peak in 2007.
In the event of a rapid correction those most severely affected would have just come into the market with low deposits, Wheeler said.
Although the bank expects the curbs on high loan-to-value ratio lending will have their main effect in the first year, Wheeler was non-committal about how long the curbs might remain.
"We would see them being removed when we get a better balance in the housing market and we are confident their removal will not lead to a resur-gence in house price inflation."
The bank's forecasts have the pace of economic growth picking up from around 2.5 per cent now to 3.5 per cent by the middle of next year. Unemployment is forecast to ease from 6.4 per cent now to 5 per cent by early 2016.
Underpinning the pick-up are the rebuilding of Christchurch, buoyant housing markets in the two largest cities spilling over into higher consumption, high export prices (especially for dairy products), and the turnaround in net migration. In addition, though longer-term fixed mortgage rates have already risen in line with global interest rates, mortgage rates remain historically low.
Offsetting that is the Government's fiscal policy, expected to reduce demand in the economy by the equivalent of 0.5 per cent of gross domestic product a year, and a high exchange rate.
The dollar jumped more than half a cent against the US dollar when the monetary policy statement was released.
"All up, it's hard to go against the spirit of what the Reserve Bank is saying," said ANZ chief economist Cameron Bagrie. "Inflation risks are rising and interest rates will need to rise too."
Westpac chief economist Dominick Stephens said he agreed with the Reserve Bank's new stance.
"We have long argued that rising house prices and a construction boom would eventually provoke inflation pressures and would require a substantial [official cash rate] hiking cycle, similar to the experience of past decades," Stephens said.
"It is right for the central bank to warn markets and the public that a period of higher interest rates is coming.
"Indeed, moving early in this manner may limit the eventual extent of OCR hikes that are required," he said.
"Anticipation of future OCR hikes has caused markets to push fixed mortgage rates up, which will slow the housing market earlier than OCR hikes on their own could have."