New Zealand’s central bank said it would halt bond purchases this month as the Pacific nation became one of the first in the developed world to step back from a pandemic monetary stimulus.

The surprise decision by the Reserve Bank of New Zealand caused the local currency to rise sharply against the US dollar, as economists forecast the bank would raise interest rates as early as August to prevent the economy from overheating.

“Members agreed that the major downside risks of deflation and high unemployment have receded,” said Adrian Orr, the bank’s governor and head of its monetary policy committee.

“The committee agreed that a ‘least regrets’ policy now implied that the significant level of monetary support in place since mid-2020 could be reduced sooner, so as to minimise the risk of not meeting its mandate.”

The RBNZ left official rates unchanged at 0.25 per cent.

New Zealand’s economy grew 1.6 per cent in the first quarter as Jacinda Ardern’s government lifted social distancing restrictions thanks to its success suppressing Covid-19.

House prices are booming and the RBNZ predicted “more persistent” consumer price inflation in the months ahead owing to growing labour shortages and rising domestic capacity pressures.

Sharon Zollner, ANZ New Zealand chief economist, said the fact that the RBNZ statement was titled “Monetary Stimulus Reduced” was a broad hint that the RBNZ considered the monetary policy cycle to have turned.

“The RBNZ has absolutely done enough hand waving today to tick the ‘market-prep’ box for an August hike, with consumer price inflation and labour market data set to do the rest.”

The New Zealand dollar rose more than 1 per cent to $0.7017 against the US dollar on Wednesday as investors speculated that New Zealand would become the first developed nation to raise interest rates in the wake of the pandemic.

Canada’s central bank began to scale back its monthly bond-buying in April, making it the first leading central bank to reduce pandemic-related stimulus measures. Last month, Norway’s central bank said it would probably raise interest rates in September.

Michael Gordon, acting chief economist at Westpac NZ, said the tone of the RBNZ statement was more hawkish than expected and the odds had tipped towards a 25 basis point rise in August.

“RBNZ explicitly drew a close to its bond purchase programme, and described this as a removal of policy stimulus, rather than letting it quietly wind down as they have done over recent weeks,” he said.

The RBNZ launched its programme of quantitative easing bond purchases in March 2020 as coronavirus swept across the developed world, pushing economies into recession. The central bank said on Wednesday that it would halt its bond-buying programme by July 23. It was originally scheduled to run until June 2022.

Additional reporting Richard Milne in Oslo