Australia Leads Developed Economies In Reversing Accommodative Policy

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Australia became the first G-20 member nation to hike its benchmark interest rate since the onset of the financial crisis in late 2008, indicating that a global recovery is underway. Tuesday, the Reserve Bank of Australia surprisingly raised its interest rate by 25 basis points to 3.25% after economists had widely expected the cash rate to be retained at its 49-year low of 3%. Interest rates had been kept at their ultra-low setting since April this year.

The central bank's move contrasts with the stance of other major central banks around the world, with the European Central Bank, Bank of Japan and the Federal Reserve all expected to retain an ultra-low policy setting amid fears that premature tightening could choke off a sustained recovery.

RBA Governor, Glenn Stevens said in his monetary policy statement that with economic conditions improving again, and with no risk of a serious economic contraction in Australia, the need for an ultra-low interest rate has now passed. Stevens added, "The Board's view is that it is now prudent to begin gradually lessening the stimulus provided by monetary policy."

He noted that economic conditions in Australia were stronger than expected and that confidence had improved. Medium-term prospects for investment appears to be strengthening, while higher dwelling activity and public infrastructure will also give support to spending. Hence, growth is likely to be close to trend going into 2010, Stevens said.

Further, he said that unemployment had not risen as much as expected. Moderation in labor costs and earlier declines in energy and commodity prices helped to lower inflation. But measures of underlying inflation remained higher than the target on the latest reading.

Stevens added that underlying inflation should continue to moderate in the near term and that inflation will probably not fall as far from the target as earlier thought.

Housing credit had posted solid growth and dwelling prices have been on the rise for the past six months. Although business borrowing had been in decline, larger firms have had good access to equity capital and debt markets, on the back of better-than-expected economic conditions. Share markets have also recovered significant ground.

Stevens pointed out that interest rates on fixed-rate loans had already risen, in anticipation of a hike in the key rate. Further, the exchange rate had appreciated considerably over the past year, reducing price pressures. Taking all these factors on board, Stevens and company raised the key rate saying that a tighter policy "will work to increase the sustainability of growth in economic activity and keep inflation consistent with the target over the years ahead."

The decision to raise the cash rate comes after the Melbourne Institute and TD Securities announced last week that a monthly inflation gauge for Australia rose at its slowest pace in seven years in September. The gauge rose 1.3% year-on-year, marking the fifth consecutive month that inflation came in below the RBA's target range of 2%-3%.

TD Securities Senior Strategist Annette Beacher had indicated then that the central bank would most certainly leave the cash rate unchanged at its next monetary policy meeting saying that inflationary pressures were "clearly absent" and that annual inflation was at a "comfortably low level when assessing the current stance of monetary policy."

In its preview on the monetary policy meeting, Commonwealth Bank had said it expected an upward adjustment in rates only in the first quarter of 2010, with rates forecast to be increased to 5% by early 2011.

Although the global economy is still fragile, with pockets of strength emerging among some Asian economies and stray reports from the U.S and euro area pointing a move towards stabilization from one of the severest downturns, central banks and finance ministers have begun discussing about exit strategies, which will help withdraw monetary stimulus in a timely manner in the eventuality of inflation expectations rising. But none of the central banks have been bold enough to draw a timetable for the withdrawal for fear that growth may be nipped in the bud.

The Australian dollar that traded lower against its major counterparts during Tuesday's early Asian trading, jumped following RBA's rate decision. The aussie is now trading at a 4-day high against the Canadian dollar and a 5-day high against the yen, euro and the U.S. dollar.

Australia became the first G-20 member nation to hike its benchmark interest rate since the onset of the financial crisis in late 2008, indicating that a global recovery is underway. Tuesday, the Reserve Bank of Australia surprisingly raised its interest rate by 25 basis points to 3.25% after economists had widely expected the cash rate to be retained at its 49-year low of 3%. Interest rates had been kept at their ultra-low setting since April this year. (Market News Provided by RTTNews)