* NZ central bank keeps rate steady at 2.5 percent
* RBNZ reiterates it expects low rates until mid-year
* Higher funding costs reduce extent of future rate rises
* NZ dollar, debt settle lower after decision
By Mantik Kusjanto and Gyles Beckford
WELLINGTON, March 11 (Reuters) - New Zealand's central bank said on Thursday that the peak of its interest rate cycle would be lower than in the past, forcing investors to scale back bets on rate rises by more than a percentage point.
Reserve Bank of NZ Governor Alan Bollard said he was in no hurry to start raising rates from the current record low 2.5 percent before the middle of year as the country's economic recovery was still too subdued.
Borrowing costs for mortgages and other funding were already rising in retail and commercial markets, reducing the extent of future increases in official rates, he added.
"We believe we probably won't need to push up rates as high as they were last cycle...it's possible the neutral rate required to reach a neutral level is lower than it used to be," Bollard told Reuters Television.
In the past, a neutral cash rate level has been seen around 5.5-6 percent, but analysts suggested it might now be as much as 150 basis below that point. ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^
To see the Reuters Insider TV interview with Bollard, click: http://link.reuters.com/fez63j
For a graphic on NZ interest rates against the kiwi dollar: http://graphics.thomsonreuters.com/310/NZ_RTS0310.gif ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^
"It still looks like we're on target for a tightening around the middle of the year, which is most likely to be in June, not before that, with a risk it may be slightly later," said Deutsche Bank chief economist Darren Gibbs.
Interest rate futures <0#NBB:> rallied up to 9 basis points as investors scaled back the chances of a rate rise any earlier than June, and bet that rises after that would be small and gradual.
The New Zealand dollar
The RBNZ raised the official cash rate (OCR) 11 times between January 2004 and July 2007 to a record 8.25 percent, before embarking on a rapid cutting spree to the current level by April last year in response to the global financial crisis and a prolonged domestic recession.
Since the RBNZ moved to the OCR as its primary monetary tool in March 1999, previous cycles have seen it peak at 6.5 percent in early 2001 and 5.75 percent in early 2003.
The margins of bank funding have risen five times from 20 to 30 basis points before the financial crisis, according the monetary policy statement released with the rate decision.
Home mortgages haven risen by up to 40 basis points for fixed-rate loans between one and two years since December.
"We believe the RBNZ's view of the neutral OCR is around 100-150 basis points lower than pre-crisis levels," said ASB bank economist Jane Turner.
The Reserve Bank of Australia (RBA) has also previously estimated that effective lending rates were over 100 basis points above its cash rate, a big change from before the global credit crisis when they were virtually the same.
Last December RBA Deputy Governor Ric Battellino said the 3.75 percent cash rate was actually the equivalent of a 4.75 percent rate pre-crisis because local lenders had been raising their rates on loans more aggressively than the central bank. The remarks suggested it would not have to lift its cash rate as far as it might have in the past.
Last week, the RBA raised its cash rate to 4 percent and hinted that more rate hikes were to come.
NO HURRY
Bollard said businesses and consumers remained cautious as the country emerges from recession and the central bank wanted to see signs of a more robust recovery before raising rates.
"We think we're quite safe to wait and watch while we need to," Bollard said, adding that the strength and make up of recovery would dictate the speed and extent of rate rises.
He said that, besides Australia and China, growth among New Zealand's key trading partners remained muted, while tighter financial market conditions were reducing the level of stimulus and doing some of the tightening for the central bank.
"We expect these (higher bank funding) costs to persist over the projection, reducing the extent of future increases in the OCR (official cash rate)," Bollard said in a statement.
"We continue to expect to begin removing policy stimulus around the middle of 2010."
A Reuters poll after the decision had 10 of 15 economists picking the first rise in June, with two seeing an April rise and three a third quarter hike. [NZ/POLL]
Interest rate swaps
"Markets are scaling back how much is priced in further out," said ANZ-National senior markets economist Khoon Goh.
The amount of tightening over the next 12 months eased to
144 basis points from 147 basis points the previous day and a
peak of 241 basis points in late October, a Credit Suisse
indicator
Financial markets are now pricing in a rate hike in each meeting from June onwards.
Separately, a survey showed New Zealand's manufacturing sector expanded for the sixth month in a row in February, with a steady flow of new orders backing views that economic conditions were improving, while food prices fell 1.3 percent. [ID:nSGE6290N7] and [ID:nWEL003979] (Additional reporting by Adrian Bathgate; Graphic by Catherine Trevethan; Editing by Kim Coghill)