When it releases its monetary policy statement on Thursday the Reserve Bank is expected to turn up the volume on its warning that it is preparing to remove the support of ultra-low interest rates in place since the recession.
Financial markets have fully priced in a rise in the official cash rate from 2.5 per cent to 2.75 per cent by the end of March and at least a full percentage point by this time next year, with more to come beyond that, and a Reuters poll of 16 banks and other economic forecasters found 12 of them expect the first increase in the OCR in the March quarter next year.
Deutsche Bank chief economist Darren Gibbs said the underlying economic and inflation story in Thursday's statement should be a little stronger than was depicted in the September statement, but that would have to balanced against a stronger exchange rate.
"As a result we expect that the Reserve Bank will continue to project around 100 basis points of OCR tightening in 2014, with the projections and commentary likely to hint that the first tightening will probably occur at the March monetary policy statement."
The exchange rate is 3 per cent higher on a trade-weighted basis than the Bank assumed it would be at the time of its September statement.
Longer-term fixed mortgage rates have already risen, under the influence of a global rise in bond yields. One consequence is that with nearly three-quarters of mortgages either floating or fixed for less than a year, monetary policy should have some real bite when it moves, ANZ chief economist Cameron Bagrie said.
On October 1, the Reserve Bank introduced curbs on low-deposit mortgage lending. While the primary objective was to bolster financial stability, the regime has implications for monetary policy. The Bank is expected to reiterate its warning that how much and when it raises the OCR will "depend on the degree to which the momentum in the housing market and construction sector spills over into broader inflation pressures".
The other main change since the September statement has been the appreciation of the kiwi dollar, as the US Federal Reserve pushed back expectations of when it will start to taper off its bond purchases, and the strength of New Zealand export prices has pushed the terms of trade to a 40-year high.
A higher dollar would make the Reserve Bank more reluctant to raise interest rates and in its October OCR review the bank explicitly acknowledged that sustained strength in the exchange rate give it "greater flexibility as to the timing and magnitude of future increases in the OCR".
Bagrie said New Zealand could lead the developed world in hiking. "But [the bank] will not want to get too far out in front, for fear of sending the exchange rate to the moon. This suggests a relatively cautious hiking cycle," he said.
"The New Zealand dollar is very high, but history shows that if you become too fearful of it, and end up behind the curve as a result, the currency can be perceived as a one-way bet for carry traders. The OCR and the currency can end up overshooting further than if the bullet had been bitten earlier on."
Previous Reserve Bank governor Alan Bollard made it clear early on he would rather take a risk on inflation than growth and failed to get his inflation-fighting credentials established early, Bagrie said.
He doubts Graeme Wheeler will repeat that mistake, noting that "he hasn't even blinked in response to the political maelstrom around the LVR speed limits".
Bank of New Zealand economists say there is no simple see-saw trade-off relationship between interest rates and the exchange rate when it comes to overall monetary conditions.
"If only it were that simple," BNZ economist Craig Ebert said. "Interest rates, as a rule, are the more powerful in their impacts on the economy and thus the consumers price index, as compared to the exchange rate."