New Zealand's central bank took markets by surprise yesterday, raising its key interest rate to a record high 8 percent from 7.75 percent in a move to curb inflation.
The Reserve Bank cited strong domestic demand, a buoyant house market, strong employment and investment intentions, robust consumer confidence and increasing government spending as pressures toward inflation.
Yesterday's 25-basis-point hike in the Official Cash Rate was the central bank's third so far this year, with the 8 percent rate the highest since the benchmark rate was introduced in March 1999.
The bank said it was aiming to ensure that inflation remains within a 1 percent to 3 percent range over the medium term.
"Had we not increased the OCR this year, it is likely that the inflation outlook would now be looking uncomfortably high," Reserve Bank Governor Alan Bollard said in the June Monetary Policy Statement.
New Zealand's on-year inflation eased to 2.5 percent in the three months ended March 31, from 2.6 percent in the fourth quarter. But domestic inflation, which excludes import prices, remains at an uncomfortably high 4.1 percent.
Bollard reiterated earlier comments that the New Zealand dollar is trading at exceptionally high and unjustified levels. The New Zealand dollar hit a 25-year high of US$0.7554 this week.
On Wednesday, the European Central Bank (ECB) raised borrowing costs to their highest level in nearly six years, pointing to a humming economy that, while welcome, raised the risk of higher inflation. It also hinted at additional increases, prompting a slide in European stock markets.
The ECB lifted its benchmark interest rate for the 13 countries that use the euro by a quarter percentage point, to 4 percent. That was the eighth increase since December 2005, when the bank began increasing the cost of credit in advance of an economic recovery. Europe is now growing faster than the US.
Bank President Jean-Claude Trichet while declining to commit to a timetable, left little doubt that the bank saw the need for higher interest rates to ward off the threat of higher inflation.
The ECB's strategy has focused on getting ahead of what it sees as inflationary threats from energy prices, increasing bottlenecks in European production -- which allow companies to raise prices more quickly -- and rising wages, which can feed into higher consumer prices. It has also sought to curb explosive bank lending brought on by low interest rates around the world.
For now, the bank has kept inflation under firm control. On a monthly rate, it is now running at less than 2 percent, almost precisely within the bank's target.
"What we have been doing since December 2005 has served us very well," Trichet said. "We have been fully vindicated."
The ECB has wagered that a strong global economy would continue to stoke economic growth in Europe by buying its exports and that business conditions in the US would pick up as the year progressed, as the US Federal Reserve has predicted.
In the statement issued after its regular monthly meeting, the ECB slightly modified the language that it employed to describe interest rates to hint at future increases. It said that rates were "still" accommodating European economic growth, a formulation that Trichet said was an oblique way of indicating that the bank would not stop at 4 percent.
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