Reserve Bank Governor Graeme Wheeler has expressed disquiet over rising house prices.
Mr Wheeler again left the Official Cash Rate on hold in its latest review on Thursday but said he was watching house prices closely.
The official cash rate has been at a record low 2.5% since March 2011.
Mr Wheeler said the Reserve Bank does not want to see buyer demand get so far ahead of the supply of houses that it poses a risk to inflation getting out of control, or even to the stability of the banking system.
He said th Bank is watching house prices and the growth in lending to households.
For the first time since taking over as governor last year, Mr Wheeler described the New Zealand dollar as overvalued.
He said that is helping suppress inflation but is also undermining profits of exporters and firms whose products compete with imports.
In his statement on Thursday Mr Wheeler gave a list of factors that would boost the economy in 2013, such as improving business confidence, construction activity and trading prospects.
However he flagged as risks the weak job market, as well as the overvalued New Zealand dollar.
Overall, though, the bank expected economic growth to strengthen over the coming year and "on balance, it remains appropriate for the OCR to be held at 2.5%", Mr Wheeler's statement said.
Dollar continues rise
The New Zealand dollar rose after the Reserve Bank statement, as currency traders chose to focus on Graeme Wheeler's comments on house prices rather than the dollar.
The Kiwi held its ground on Thursday afternoon, after surging half a cent in the morning against its US counterpart following the governor's comments and decision to keep the Official Cash Rate on hold.
Mr Wheeler said the dollar is overvalued and denting the profitability of exporters and firms competing with imports.
But currency markets preferred to focus on other statements by Mr Wheeler, that the housing market could be becoming overheated, and pushed the dollar higher.
At 5.15pm on Thursday the New Zealand dollar was buying US83.46 cents. It had been at US83c just before Mr Wheeler's statement at 9am.
Westpac currency strategist Imre Speizer said the markets had expected the lower inflation outlook to dominate the bank's statement, not the emphatically worded mention of upside inflation risks that could come from the housing market.
Mr Speizer said those who had speculated and sold the Kiwi short would have had to buy back in a hurry.
Indications GDP growth recovering
The Governor said global growth was set to recover in 2013 with economic indicators improving in many of New Zealand's trading partners.
Global financial market sentiment was positive, contributing to lower bank funding costs and some reduction in interest rates faced by households and firms.
Recent data on business confidence and construction activity suggested GDP growth was recovering and the Canterbury rebuild is gathering momentum.
"House price inflation has increased and we are watching this and household credit growth closely. The Bank does not want to see financial stability or inflation risks accentuated by housing demand getting too far ahead of supply.
"Inflation remains subdued and is currently just below the bottom of the Reserve Bank's inflation target range. This mainly reflects the impact of the overvalued New Zealand dollar.
"The high currency is directly suppressing inflation on traded goods, and is undermining profitability in export and import competing industries. At the same time, the labour market remains weak and fiscal consolidation is dampening growth."