The New Zealand dollar jumped following the Reserve Bank's decision to lift the cost of borrowing, rising almost one cent to about 74 US cents.
The central bank on Thursday raised the official cash rate by a quarter percentage point to 6.75%, saying the hike is needed to stop inflation getting away.
It's the first move in the benchmark interest rate in four months, and takes it to the highest level since the rate was established in 1999.
Governor Alan Bollard said the economy is proving to be stronger than expected for longer, which is generating stronger underlying inflation.
He said the economy is getting stretched with strong employment growth, high levels of business and consumer confidence, and investment at record levels.
On top of that, he said exports are holding up despite the appreciating New Zealand dollar, as farmers enjoy high commodity prices.
Bollard said he saw very little impact on the dollar from the rise in interest rates.
The official cash rate has been on hold since a quarter percentage point rise in October last year.
More to come?
The Reserve Bank has left the door open for further interest rate rises as inflationary pressures threaten to get out of control.
Eight of 14 economists in a poll by news agency Reuters had forecast no change for the benchmark rate, with the chances of a rate rise put at 45%. The median expectation was that the next move will be a quarter-point cut in the first quarter of 2006.
"Not responding to the prospect of stronger inflation pressures now would create a risk that inflation expectations and wage and price setting behaviour could change in a way that would make the task of containing inflation more difficult in the future, even if growth slows," Bollard said.
He said the impact of the Reserve Bank's six rate hikes last year is still working its way through the economy which is close to turning point.
A slowdown is still expected and the central bank is mindful further rate rises might exacerbate the downturn, Bollard says.
"Being prudent now reduces the prospect of a tighter monetary policy later on," he says.
"Whether there is any further tightening ahead will depend on how the risks play out over the coming period. Certainly, the current outlook offers little scope for an easing of policy in the foreseeable future."
New Zealand's cash rate compares with official rates of 5.5% in Australia, and 2.5% in the United States and 2% in the euro zone.
