New Zealand’s central bank on Thursday raised its key interest rate to 7.5 per cent, the highest level in years, suggesting that the country will continue to attract strong interest from investors looking to switch to high-yield currencies.

The Kiwi dollar has traditionally been one of the main targets of the global carry trade, where investors borrow cheaply in the currencies of countries with low interest rates in order to buy into high-yield currencies.

Japanese investors have been among those focusing on the yield spread between their domestic market and New Zealand, boosting the volume of yen-funded carry trades and the issuance of Uridashi bonds, which are sold to Japanese retail investors. However, the New Zealand rate increase comes amid a vigorous debate over whether Japanese investors will continue using the carry trade in a more risky market environment.

Chris Tennent-Brown, New Zealand economist for Commonwealth Bank of Australia, said: ”The most important thing about this rate hike is perhaps that the carry trade has just got a little bit better. Most people are now factoring that the rates should stay higher for probably longer than what we thought six months or a year ago. The downturn in China has certainly given people the jitters, the talk is that the carry trade is being unwound, but there is in fact a fairly compelling case for the carry trade going forward.’’

The latest rate move is also likely to mean that substantial amounts of Uridashi bonds due to mature later this year will be rolled over, according to Mr Tennent-Brown.

The Reserve Bank of New Zealand raised its benchmark rate by 25 basis points, leaving the door open for a further increase as the economy continues to grow on the back of a booming housing market and higher consumer spending.

The central bank is trying to keep inflation within a target range of 1 to 3 per cent. It forecast Thursday that annual inflation was on course to reach 2.3 per cent by March 2008 and 2.7 per cent a year later.

Alan Bollard, its chairman, said in a statement: ”Depending on the persistence of the current upturn, further tightening may be required. A return to a moderating trend in housing and domestic demand will be essential if we are to see a reduction in medium-term inflation pressures.’’

However, the kiwi dollar fell on Thursday as investors had anticipated the rate increase and were disappointed that the comments from the central bank’s governor did not lean more clearly towards further rises.

Stephen Koukoulas, global strategist at TD Securities in Sydney, said: “The market views the statement as less hawkish than expected, a view that we share… On balance, we believe that official interest rates are more likely to remain on hold than rise further in the future.’’

The kiwi dollar fell to 67.98 US cents in late afternoon trading, compared with 68.51 cents before the rate announcement.

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