The Reserve Bank governor is warning mortgage rates could jump to as high as 8 per cent in the next two years.
Graeme Wheeler has also taken a swipe at Labour's proposal for exemptions from new mortgage lending rules.
He said they would be difficult to administer and could push up the price of low cost housing.
In an opinion piece today, Wheeler, who refuses to give media interviews, defended the central bank's decision to impose new rules to reduce the amount of low-deposit lending.
From the start of the month no more than 10 per cent of bank lending on residential housing can be to borrowers with a deposit of less than 20 per cent.
In his opinion piece, Wheeler addressed calls for an exemption for first-home buyers, and a regional exemption, both promised by new Labour leader David Cunliffe.
"Some suggest that loan-to-value restrictions should be applied regionally, especially around Auckland, or that we should exempt buyers of lower-priced houses," Wheeler wrote.
"We considered both options. However, regional restrictions would be hard to administer and would shift housing pressures outside wherever the boundary is drawn.
"Exempting low-priced housing would be a recipe for rapid increases in the cost of such housing.
"Broad exemptions to other groups such as first-home buyers would substantially undermine the effectiveness of the restrictions in reducing house price inflation."
Wheeler also said the Official Cash Rate (OCR) was likely to rise over the next two years by two percentage points.
"This could result in interest rates on first mortgages of 7 per cent to 8 per cent," he warned.
"If the loan-to-value speed limit is unable to slow house price inflation, larger increases in the official cash rate would be required."
He said pressure on the housing market needed to be reduced, especially given banks had been "competing aggressively" for low-deposit borrowers.
The New Zealand dollar surged against the greenback and Australian dollar after Wheeler's comments that he would raise interest rates faster and harder if the new mortgage lending limits did not slow rising house prices.
The kiwi recently traded at 83.33 US cents from US82.56c before to Wheeler’s comments. It was also up about half a cent against the aussie to recently trade at 88.72 Australian cents.
Labour finance spokesman David Parker said the Reserve Bank had been ''forced into a corner by the government's inaction'' on rising house prices, a shortage of affordable homes and property speculation.
''We believe that LVR restrictions are too onerous on first home buyers, 70 per cent of whom need a high LVR loan to buy a house. We remain of the view that LVRs would not need to be applied to first home buyers if the Government (not the Reserve Bank) was properly addressing housing supply and demand issues. The Government should not hide behind the independence of the Reserve Bank, which is not responsible for the failure of the Government's housing policy.''
Parker was adamant that regions could be stripped out from the rules.
"It makes no sense for LVRs to apply in regions without high house price inflation. We don't believe it is too difficult to define a suitable boundary based on regional house price inflation."
Meanwhile the chairman of ANZ (the parent company of the New Zealand bank of the same name), John Morschel, said the LVR rules in New Zealand ''seems to me like a bit of a sledgehammer to crack a walnut''.
- © Fairfax NZ News