NZ central bank looks ahead to faster inflation, earlier hike

By Ana Nicolaci da Costa and Charlotte Greenfield

WELLINGTON (Reuters) - Fiscal stimulus from a new Labour-led government and a weaker currency would lead to faster inflation and probably an earlier rise in interest rates, New Zealand's central bank said on Thursday - sending the local dollar sharply higher.

The Reserve Bank of New Zealand (RBNZ) held interest rates steady at 1.75 percent as expected, and said policies proposed by the new Labour-led government could boost economic growth by around half a percentage point in each of the next three years.

The RBNZ also projected a possible rise in interest rates for the second quarter of 2019, three months earlier than previously expected.

Investors responded by bidding up the local dollar to as high as $0.6973. It was last trading at $0.6947.

"With the change of government, changes to fiscal policy and broader economic policy are expected to provide additional stimulus to the economy," the central bank said.

That stimulus would help offset weakness in housing and construction and, combined with a lower currency, lift inflation to the middle of its 1 percent to 3 percent target band almost a year earlier than previously forecast.

"I think fiscal policy is the biggest swing factor here," said Philip Borkin, senior economist at ANZ Bank.

"They've factored in things preliminarily which we didn't think they would, so that's made them a little bit more upbeat on growth."

CURRENCY FALL WELCOMED

The currency is still down more than 7 percent since mid-year, a fall welcomed by RBNZ Governor Grant Spencer who said it was now much nearer to being fair value.

In an interview with Reuters, RBNZ Assistant Governor John McDermott said it would be "fine" if the New Zealand dollar were to fall further. "A little bit more is good," he said.

Spencer cautioned, though, that the likely impact of Labour's progressive polices was "very uncertain", given full details were not yet available.

The left-leaning government of Prime Minster Jacinda Ardern was sworn in just two weeks ago after forming a coalition with two minor parties.

Among its sweeping new proposals are new government spending, a homebuilding programme, curbs on immigration and hefty increases in the minimum wage - all of which the central bank said was on its radar.

Also underway are changes to the RBNZ's mandate to include maximising employment as a policy goal alongside control of inflation.

That review stirred concerns among foreign investors that the bank might leave rates too low for too long and risk an outbreak of inflation.

"Moving to a dual mandate is unlikely to have a major impact on the way that we run monetary policy," Spencer told a news conference in Wellington.

A new governor is due to be appointed by March next year. Spencer, who plans to retire, said the selection process was well underway.

(Reporting by Ana Nicolaci da Costa and Charlotte Greenfield; Additional Reporting by Swati Pandey in Sydney; Writing by Wayne Cole and Tom Brown; Editing by Eric Meijer)