Markets are challenging the Reserve Bank of New Zealand with higher bond yields and a rising currency, but the central bank has retaliated with hints that it could respond to undesirably tight financial conditions by slashing the cash rate.

RBNZ governor Adrian Orr said “we are very aware of the rise in global bond yields. They directly impact on funding costs for banks which then pass that on to retail lending rates.”

The 10-year New Zealand government bond yield jumped from 1.598 per cent to 1.681 per cent in the afternoon. The New Zealand dollar is back at April 2018 levels, trading at US73.63¢.

While Governor Orr said he is pleased about the positive reasons for rising bond yields - such as higher growth and increased inflation expectations from historically low levels - he warned that if financial conditions tighten to unhelpful levels then “we will alter our settings”.

“If we thought that monetary conditions were inconsistent with what we need, then we are prepared to move,” he said. “The OCR” - official cash rate - “can go lower”.

Read the full story at afr.com.