Dr Bollard briefed the finance select committee today just hours after he surprised many economists by lifting the Official Cash Rate to a record 8 per cent from 7.75 per cent.
He told MPs the inflationary outlook remained strong for the next two years –, an election must be held by November 2008.
National's finance spokesman, Bill English, said about one third of existing fixed rate mortgages would be refinanced in the next 12 months, with people moving from rates of 7.8 per cent to rates closer to 9 per cent.
Floating interest rates have already crept above 10 per cent for first time since July 1998.
Dr Bollard said the bank had been taken by surprise by the size of the increase in the pay out to dairy farmers, which would inject around $2 billion into the economy over the next two years.
If farmers spent this money rather than use it to repay debt then this would create more inflationary pressure.
National MPs grilled Dr Bollard over the impact of government spending increasing at a faster rate than household consumption and the effect that was having on the interest rate.
Bank officials said government spending made up only 20 per cent of GDP, compared to private spending 60 per cent shares.
They said while government spending had some inflationary pressure the bank did not differentiate between the quality of that expenditure.
Officials said they would be watching with interest on who joined the KiwiSaver scheme and how it affected savings patterns.
The Reserve Bank has assumed it would have a zero impact on net savings at this stage.
The assumption is based on the belief that new savers who join the scheme and add to national savings levels, will be offset by those all ready saving using the government subsidy to reduce their saving levels and increase spending.
Dr Bollard also gave MPs some details on his talks with banks and his concerns about their lending activities.
The banks had provided him with details of the risks they were taking out on mortgages of sometimes up to more than 100 per cent of a house's value.
Dr Bollard said there had been some level of risk, but he had been reassured it was not as bad as he feared.
The risks being taken by banks in New Zealand was not near the risks being taken by their counterparts in the United States, he told MPs
There has been controversy in the US with bank's subsidiaries handing out mortgages to low or fixed income people, who can not afford the repayments when interests rates rise.
Dr Bollard said he had received a "useful response" from the banks, but refused to elaborate on the private meetings.
Mr English spent some time quizzing Dr Bollard over his and Finance Minister Michael Cullen's concerns about the lack of alternative monetary policy tools besides lifting interest rates.
Dr Bollard said lifting interest did work, but not as quickly as he would like.
The finance select committee was beginning an inquiry into monetary policy and Dr Bollard said he was hoping MPs could come up with some new ideas.
Mr English said the two people who had the most influence over monetary policy – Dr Bollard and Dr Cullen – had just renewed their policy target agreements and had made no changes.
Dr Bollard said some of the options being looked at –- which included a tax on mortgages – would require political consensus.
Dr Cullen said in a statment that in his haste to criticise government spending, Mr English had ignored the main factors for the rise – the dairy payout and high household debt
He challenged Mr English to say how National would cut rising government spending and fund tax cuts.
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