The Official Cash Rate has climbed 25 basis points to 0.75 percent, the Reserve Bank confirms.
It follows a 25 basis point rate rise in October which took the wholesale cash rate off its emergency 0.25 percent setting in response to the COVID-19 pandemic.
Making its final monetary policy announcement of the year, the Reserve Bank said on Wednesday global economic activity continues to recover as vaccination rates increase and restrictions ease.
Before the COVID-19 Delta outbreak in August, the New Zealand economy was in a strong position, supported by household spending, strong construction activity, and demand for key exports.
"The Monetary Policy Committee agreed to raise the Official Cash Rate (OCR) to 0.75 per cent," the Reserve Bank said in a statement.
The COVID-19 Delta outbreak which plunged New Zealand into lockdown on August 18, followed by prolonged restrictions in Auckland, Northland and Waikato (and level 2 restrictions elsewhere), resulted in a sharp contraction in economic activity.
"Despite these lockdowns, underlying economic strength remains supported by aggregate household and business balance sheet strength, fiscal policy support, and strong export returns," the statement said.
Capacity pressures in the economy have continued to tighten. Employment is now above the maximum sustainable level.
Consumer price inflation is expected to rise above 5 percent in the short-term, driven by higher oil prices, rising transport costs and supply shortfalls, returning back towards 2 percent over the next two years.
"A broad range of economic indicators highlight that the New Zealand economy continues to perform above its current potential," the Reserve Bank said.
As the country adapts to living with COVID-19, there is uncertainty around the level of consumer spending and business investment. Acknowledging interest rates had already increased, the Reserve Bank said there was concern high levels of household debt and fixed rate mortgages rolling over could impact spending.
It agreed on a "considered steps" approach to reducing the Official Cash Rate, and therefore the level of monetary stimulus in the economy.
Infometrics principal economist Brad Olsen said although the 25 basis point rise was expected, taking current inflationary and labour market pressures into account, the Reserve Bank had the opportunity to get ahead of the curve.
Wednesday's decision was a "weak and spineless move", he said.
"Today was the day to get in front of these pressures, to be proactive and this more cautious approach the Reserve Bank has adopted (which we expected), will see inflation run hotter for longer," Olsen said.
If inflationary pressures and expectations of higher inflation become embedded into behavior, there is potential for it to rise above the Reserve Banks 5.7 percent near-term inflation forecast (December 2021 and March 2022 quarters).
And it's next policy review is another three months away, on February 23.
"Given the pressures we've already seen (since the 4.9 annual CPI increase in the September quarter), we would expect to see those presssures continue to build," Olsen added.
Independent economist Cameron Bagrie said higher inflation, more capacity pressure and low unemployment gave the Reserve Bank reason to lift the cash rate by 50 basis points.
On the flip side, heading into 2022, there's still a lot of uncertainty about the resilience of the economy as the country learns to adapt to living with the virus.
In August, the Reserve Bank signaled the Official Cash Rate was going to go back to a "neutral rate" of around 2 percent, Bagrie said. In Wednesday's release, the Reserve Bank signaled due to inflation pressures, it would need to "start tapping on the brakes".
Reserve Bank forecasts show the cash rate heading into the 2.5 percent to 3 percent zone from the third quarter of 2023.
"That will mean for borrowers, at some stage we're going to see one and two-year fixed borrowing head up towards 5 [percent]," Bagrie said.
