While the following information relates to the recent interest rate rise in New Zealand, there is not much difference in the financial systems in N.Z. and Australia. The comments of the Governer of the RBNZ are just as relevant to Australia as they are to N.Z.
In late October the Reserve Bank of New Zealand increased the Official Cash Rate (OCR) by 25 basis points to 7.00 per cent.
In his accompanying speech Reserve Bank Governor Alan Bollard said: "As noted in our September Monetary Policy Statement, medium term inflation risks remain strong. Persistently buoyant housing activity and related consumption, higher oil prices and the risk of flow-through into inflation expectations, and a more expansionary fiscal policy are all of concern. While there has been a noticeable slowing in economic activity, and a particular weakening in the export sector, we have seen ongoing momentum in domestic demand and persistently tight capacity constraints. Hence, we remain concerned that inflation pressures are not abating sufficiently to achieve our medium term target, prompting us to raise the OCR today.
"The most serious risk to medium term inflation is the continuing strength of household spending, supported by a relentless housing market and rapid growth in mortgage lending. Significant dis-saving by the household sector is showing through in a worsening current account deficit, now 8 per cent of GDP. Borrowers and lenders alike need to recognise that the current rate of debt accumulation is unsustainable. The correction of these imbalances and associated inflation pressures will require a slowdown in housing, credit growth and domestic spending. We also expect a significantly lower exchange rate. The longer these adjustments in behaviour and asset prices are deferred, the more disruptive they are likely to be.
"Today's increase in the OCR, combined with higher world interest rates and pipeline effects from the repricing of fixed rate mortgages, are expected to slow the housing market and household spending over the coming months. However, the prospect of further tightening may only be ruled out once a noticeable moderation in housing and consumer spending is observed. Certainly, we see no prospect of an easing in the foreseeable future if inflation is to be kept within the 1 per cent to 3 per cent target range on average over the medium term."
New Zealand's cash rate of 7% compares with official rates of 5.5% in Australia, 3.75% in the United States and 2.0% in the euro zone.
Annual inflation in New Zealand rose to a five-year high of 3.4% in the third quarter, boosted by higher oil and housing prices. It was the first time the rate has breached the RBNZ's 1-3 percent target band in four years.
Bollard said banks and other lenders, who have fuelled domestic spending through lending, needed to focus on their "long-term interests", which would not be achieved "if they promote loans to people who cannot afford them".
N.Z. House prices, which rose around 14 percent in the last year were at unsustainably high levels, and comments made by the property industry that activity would continue at such levels were "self serving and unhelpful".
The government also had a responsibility to reduce fiscal pressures, Bollard said.