"If there is a simple message, it is that we have to hold the line," he said.
But he told the Auckland audience that double-digit inflation in Auckland house prices was "really bad".
"It's not sustainable. It will eventually drive the banks to continue to increase their loan-to-value ratios because more consumers will want to get on the train," he said.
"Secondly, if there is anything that really determined New Zealand's fate in the global financial crisis, it was that the banking sector in New Zealand - which is the Australian banks - was very healthy.
"The thing that killed the US economy was the destruction of their banking system, particularly the sub-prime mortgages, so if you get a massive bubble in your economy it's bad for the economy long-term."
He said Reserve Bank Governor Graeme Wheeler did not want to raise interest rates because of Auckland house prices, because it would drive up the exchange rate at a time when three-quarters of world output was being produced by countries with interest rates at or below 1 per cent.
Instead, he expected Mr Wheeler to use new tools such as restricting the banks' loan to value ratios, possibly with exceptions for first-home buyers.
Last week the Reserve Bank raised the risk weights applied to housing loans granted by the four largest banks that have a loan-to-value ratio above 80 per cent, effectively raising the capital held for housing by an average of around 12 per cent with effect from September 30.
"What the Governor is very conscious of is that there are a lot of first-home buyers who do want to borrow a bit more than that," Mr Key said.
"So it's entirely possible that he will have speed limits and go to the banks and say you can have a carve-out for first-home buyers."
