Australia central bank raises rates; more to come

SYDNEY: Australia's central bank raised its cash rate by 25 basis points to 4% on March 2 and flagged further hikes ahead, saying a surprisingly strong recovery allowed it to move policy toward more normal settings.

Interest rate futures slid as investors priced in further gradual hikes from the Reserve Bank of Australia (RBA). A rise in April was seen as unlikely but the odds of an increase in May were evenly split and almost fully priced in for June.

"It is very likely the RBA will hike again in the next three months," said Rory Robertson, interest rate strategist at Macquarie. "It's a 'normalisation' of policy given the economy has performed better than anyone dreamed a year ago".

This was the fourth increase in five policy meetings, putting Australia far ahead of most other rich nations where rates are at 1% or less.

Indeed, RBA Governor Glenn Stevens flatly stated that lending rates were still below average and March 2's move was just a step toward getting back there.

"With growth likely to be close to trend and inflation close to target over the coming year, it is appropriate for interest rates to be closer to average," Stevens said in a statement.

Last month he estimated a more normal range for lending rates would be between 4.25% and 4.75%, and investors assume the bank will get to the top of that band by year-end.

Interbank futures are fully priced for a move to 4.25% by July, and then in stages to 4.75% by December. One-year swap rates edged up to 4.65%.

Reaction in the currency market was restrained as the Australian dollar had already risen sharply in recent days, hitting a record high on the euro and a 25-year peak on sterling.

Treasurer Wayne Swan spun the hike as a sign of Australia's relative strength. Rising mortgage rates are always unpopular in a country obsessed with home ownership.

"The economy is recovering and rate rises are an inevitable consequence of a recovering economy that is outperforming the rest of the world," Swan told reporters.

His optimism should be supported by figures due on March 3, which are expected to show the economy grew by a solid 0.9% in the fourth quarter of 2009, a marked step up from 0.2% the previous quarter.

Growth for the year is seen accelerating to around 2.4%, from a pedestrian 0.5% in the third quarter.

Some of that revival was courtesy of fiscal stimulus, which saw public spending jump 3.8% last quarter, the biggest rise in a decade. That alone should add 0.9 percentage points to gross domestic product (GDP) in the quarter.

By concentrating on the labour-intensive building sector, the fiscal splurge also helped keep people in jobs and was one reason unemployment surprised everyone by falling late last year.

The drop in the jobless rate to just 5.3% in January from a high of 5.8% in October, is a critical plank in the case for higher interest rates.

And there was more evidence the revival had gathered steam this year. Data out on March 2 showed retail sales jumped 1.2% in January, well above forecasts for a 0.5% gain and a return to growth after December's 0.9% drop.

Retail sales account for around 23% of GDP and the sector is the biggest single employer. -- Reuters