RBA Raises Key Rate To 3.75% Citing Improved Conditions

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Strengthening the view that the Australian economy is improving steadily, the Reserve Bank of Australia raised its key interest rate for a third straight session, after keeping it unchanged at record low levels for five consecutive months. In October, Australia became the first G-20 nation to hike its interest rate since the onset of the global financial crisis in late 2008.

On Tuesday, the central bank raised the official cash rate by a further 25 basis points to 3.75%, in line with market expectations. "These material adjustments to the stance of monetary policy will, in the Board's view, work to increase the sustainability of growth in economic activity and keep inflation consistent with the target over the years ahead," the central bank said in a statement.

Australia's 3.75% key rate compares to near-zero interest rates in the U.S. and Japan, a 0.5% benchmark rate in the U.K. and a 1% rate in the Eurozone. With no monetary policy meeting scheduled in January, the RBA chose to tighten rates rather than having to wait until February to make its move.

"In deciding today to further wind back the policy accommodation", the J.P.Morgan chief economist Stephen Walters said, "RBA officials are taking the path of least hazard". "They are hiking while they have time on their side and the exit from emergency settings can be orderly."

The central bank pointed out that the economic downturn was relatively mild in Australia, and that measures of confidence and business conditions suggested that the economy was in a gradual recovery. "With the risk of serious economic contraction in Australia having passed, the Board has moved at recent meetings to lessen gradually the degree of monetary stimulus that was put in place when the outlook appeared to be much weaker," RBA Governor Glenn Stevens said in a statement.

Stevens noted that although the effects of fiscal stimulus on consumer demand are fading, public infrastructure spending is starting to provide more impetus to demand. There were also some signs of improvement in labor market conditions, Stevens said, adding that the unemployment rate is now likely to peak "at a considerably lower level than expected".

Further, the central bank expects underlying inflation to moderate in the near-term, though it said core inflation "will probably not fall as far as thought likely six months ago". The bank forecasts headline and underlying inflation to be "consistent" with the 2%-3% target in 2010.

Westpac chief economist Bill Evans stated that despite the hike, interest rates were "at least 75 basis points below neutral". He noted that with no rate setting meeting in January, the central bank has ample time to assess the impact of its monetary policy. "However, the key point remains that rates are still firmly in the expansionary zone, and not consistent with a central bank which believes that growth is returning to trend while inflation remains above the target band," Evans said.

Economists are looking for another quarter-point hike when the RBA Board meets on February 2. "With Australia's economy already at risk of bumping up against the same capacity constraints that blighted the last economic upswing, the RBA probably will be forced to push the policy stance into 'restrictive' territory in 2011," said J.P.Morgan's Walters, who expects the key rate to rise steadily throughout 2010.

Meanwhile, the Housing Industry Association of Australia expressed dismay at the central bank's decision, claiming that the latest rate hike will harm the chances of a strong recovery in the home building sector. "While a residential construction recovery is underway, there is compelling evidence that the magnitude of the upswing will be insufficient to make a major dent on Australia's chronic housing shortage," said Harley Dale, Chief Economist at HIA. "Today's rate increase is not helpful."

Dale queried the wisdom of the central bank's tightening policy, pointing out that inflationary pressures in the country were well contained at present. "There is no need to tap on the interest rate brakes at every meeting, especially at a time when Australia's residential construction sector is struggling to generate the momentum required to sustainably boost the nation's housing supply," he said.

The Australian dollar pared its early gains against its major counterparts following the RBA rate announcement.

Strengthening the view that the Australian economy view is improving steadily, the Reserve Bank of Australia raised its interest rate for an unprecedented third straight session, after keeping it unchanged at record low levels for five consecutive months. In October, Australia became the first G-20 nation to hike its benchmark interest rate since the onset of the global financial crisis in late 2008. (Market News Provided by RTTNews)