Comments from the Reserve Bank governor Alan Bollard to Parliament's Finance and Expenditure Select Committee saw the New Zealand dollar give up some of Thursday morning's strong gains during afternoon trading.
The Kiwi dollar gained three-quarters of a cent after the governor signalled an earlier-than-expected start to rises in the Official Cash Rate, hitting US82.4 cents in late morning trading.
It then eased back to around US82 cents after Dr Bollard told the select committee the market had "slightly overreacted".
He also repeated his view that the level of the exchange rate was negatively affecting the trading sector and was constraining the rebalancing of the New Zealand economy.
Despite the drop on Thursday afternoon, some in the financial markets are predicting the New Zealand dollar could hit a new post-float high overnight Thursday/Friday.
Earlier, financial markets had seized on the bank's confirmation that it was likely to raise the benchmark interest rate earlier than previously indicated.
The bank's previous forecasts had indicated the Official Cash Rate (OCR) would begin rising from early 2012. The latest forecast implied the rate would start going up later this year.
The currency rose immediately after the announcement and by midday was buying US82.3 cents - close to last week's post-float high of US82.6 cents.
High dollar constraining economic recovery
In his statement on the economy, Dr Bollard said the New Zealand dollar had risen substantially over the past two months.
"This appreciation, supported by high export prices for primary producers, is negatively affecting other parts of the tradable sector, constraining rebalancing of the New Zealand economy," he said.
Dr Bollard said the economy had improved over the last three months, boosted by continuing high export prices, and that firms were feeling more confident about hiring and investment.
Despite this, he said, household spending was expected to remain weak for some time, weighed down by high levels of debt.
As a result, pressures on underlying inflation remain constrained and only gradual rises were to be expected in the OCR over the coming two years.
BNZ head of research Stephen Toplis expects inflation to hit 5% next quarter.
Mr Toplis predicts the central bank will lift interest rates to 2.75% in December and another couple of hikes to 3.25% by March next year.
Effect of February earthquake
Dr Bollard said economic activity has been significantly disrupted by the Christchurch earthquake.
"However, while many firms and households - particularly within Canterbury - continue to be adversely affected, it appears the negative confidence effect of the earthquake on economic activity throughout the rest of the country has been limited," his statement said.
The statement went on to say that reconstruction in Canterbury is projected to add about 2 percentage points to GDP growth over 2012, and boost the level of activity for several years after that.