Australia Central Bank Raises Rates, Hints of More Hikes Ahead

Tuesday, 06 Apr 2010 07:30 AM

 

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Australia's central bank raised its key cash rate by 25 basis points to a 14-month high of 4.25 percent on Tuesday and flagged further moves ahead as the resource-rich nation rides a tide of Asian demand.

The Australian dollar climbed and bill futures slid after the Reserve Bank of Australia (RBA) delivered its fifth hike in seven months, far outstripping any other developed country.

And there was more to come.

"The bottom line here is that as the economy normalizes so will interest rates, so we'd still expect to see a cash rate of 5 percent by the end of the year," said Michael Blythe, chief economist at Commonwealth Bank.

Investors have already priced in just such an outcome, though they were less sure whether the central bank would move as early as its next policy meeting in May. Interbank futures were showing a one-in-three chance of a rise to 4.5 percent next month.

"The Board judges that with growth likely to be around trend and inflation close to target over the coming year, it is appropriate for interest rates to be closer to average. Today's decision is a further step in that process," the central bank said in a statement.

The RBA has indicated that average, or normal, rates would fall somewhere in the range of 4.25 to 4.75 percent.

"They are sticking to the big picture that the global economy is improving and things here are picking up," said Paul Brennan, head of market economics at Citi.

The economy has been supported by aggressive fiscal and monetary stimulus, a stable banking system and strong demand for Australia's commodity exports from Asia, especially China.

"So, rates should be raised to normal levels quickly. We expect a rise to 5.25 percent by December," said Brennan.

That would take Australian rates even further above those in other developed nations, one reason the local dollar hit a fresh record high on the euro on Tuesday.

The country's good fortune owes much to the insatiable demand for commodities from Asia, especially China and India, which is generating huge price rises for iron ore and coal, Australia's two biggest export earners.

Combined with a strong Australian dollar, which is pushing the price of imports down, this is set to deliver a sizable increase to the country's terms of trade.

To meet overseas demand resource companies have embarked on ambitious investment plans, including A$43 billion for one massive liquefied natural gas project in the Gorgon field.

Stephen Walters, chief economist at JPMorgan estimates that, added to government spending on infrastructure, there are 700 billion Australian dollars (US$647.13 billion) worth of projects in the investment pipeline, equal to about 60 percent of gross domestic product.

That in turn, has helped drive a remarkable recovery in the labor market. Almost 200,000 jobs have been created since August while the unemployment rate dropped half a percentage point to just 5.3 percent. This time last year policy makers had feared the jobless rate would top 8.0 percent.

There was more upbeat news Tuesday with ANZ's monthly survey of job adverts showing a 1.8 percent rise in March, an impressive result given it came on top of a 19.1 increase in February.

The surge in jobs has lifted household incomes and driven house prices to record highs, while also boosting the government budget through higher tax receipts and lower welfare payments.

But with skill shortages already appearing in engineering and construction, such strength also threatens to push wages higher.

"The economy is in better shape than anyone dared hope, so it's natural that rates should return to the average of the past," said Rory Robertson, interest rate strategist at Macquarie. "But that doesn't mean average is a stopping point".

"If the economy continues to grow above trend and unemployment to be below average, then the RBA will quickly shift to a tighter stance," he argued. "We could easily see rates at 6 to 6.5 percent by the end of next year."

© 2014 Thomson/Reuters. All rights reserved.

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