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Australia increases benchmark interest rate to 3.5%

SYDNEY: Australia raised its benchmark interest rate by a quarter percentage point for a second month, becoming the first nation to increase borrowing costs twice this year as the global economy recovers.

Reserve Bank Governor Glenn Stevens lifted the overnight cash rate target to 3.5% in Sydney on Nov 3, as forecast by 18 of 22 economists surveyed by Bloomberg News. The rest expected a half-point move.

Australia’s dollar and bond yields fell as traders halved bets on an increase in December after Stevens said higher rates would come “gradually.” Rising consumer confidence and Chinese demand for iron ore and coal will stoke economic growth while the currency’s 29% gain this year may hurt exporters and curb inflation, he said.

“Today’s move strikes a nice balance -- it edges the cash rate back to more normal levels without threatening the economic recovery,” said Craig James, a senior economist at Commonwealth Bank of Australia. “It is far from certain that rates will rise again in December.”

The Australian dollar fell to 90.34 US cents at 5.08pm in Sydney from 90.88 cents just before the decision was released. The two-year government bond yield dropped 19 basis points to 4.54%. A basis point is 0.01 percentage point.

Investors pared bets on whether Stevens will increase the key rate by a quarter point on Dec 1, according to Bloomberg calculations based on interbank futures on the Sydney Futures Exchange. There is a 52% chance of such a move, the futures showed at 4.28pm on Nov 3. Prior to the Nov 3 announcement expectations were at 96%.

Treasurer Wayne Swan said on Nov 2 the economy will expand faster than he previously forecast, growing 1.5% in the 12 months to June 30, 2010. In May, he forecast a 0.5% contraction. GDP will accelerate to 2.75% the following fiscal year, he said on Nov 2. The economy grew 1% in the first six months of this year.

“The adjustments at the October and November meetings will work to increase the sustainability of growth in economic activity and keep inflation consistent with the target over the years ahead,” Stevens said on Nov 3.

“The board noted that the rise in the exchange rate is likely to constrain output in the tradeables sector and dampen price pressures,” he said.

Investors, hungry for China’s economic growth, have been betting the Australian dollar is headed toward parity with the US currency for the first time, buying into the world’s biggest exporter of iron ore used in making steel.

Citigroup Inc, Calyon, Barclays Capital and National Australia Bank Ltd forecast it will trade at US$1 dollar next year, implying an additional 11% gain. Hedge funds and other large traders have more bets than at any time since July 15, 2008, that the rally will continue, data from the Washington-based Commodity Futures Trading Commission show.

Stevens has tempered his comments on the pace of rate increases and their effect on the currency, after last month signalling he was prepared to keep raising borrowing costs and tolerate further appreciation in the local dollar, the best- performing in the past 12 months of 171 currencies tracked by Bloomberg, as it “may help contain inflation”.

The central bank’s measure of core inflation, the so-called weighted median index of consumer prices, rose 3.8% in the third quarter from a year earlier, holding above the top of Governor Stevens’s target range of between 2% and 3% for a ninth straight quarter, a report showed on Oct 28.

Stevens also raised the rate by a quarter point on Oct 6. The only other countries to increase borrowing costs this year are Israel and Norway. By contrast, the US Federal Reserve has kept its benchmark rate close to zero for almost a year. The European Central Bank and Bank of England benchmark rates are at record lows of 1% and 0.5% respectively.

“The absence of more assertive rhetoric in today’s (Nov 3) statement signals clearly that the Reserve Bank will remove the policy accommodation ‘gradually’, a key word that once again was prominent in today’s statement,” said Stephen Walters, chief economist at JPMorgan Chase & Co. in Sydney.

Stevens also dropped references in Nov 3’s statement, last made in the minutes of the bank’s October meeting, that the “very expansionary setting” of monetary policy was “possibly imprudent”.

“A subtle shift in the tone of the commentary hints that officials are inclined to take each meeting on its merits,” Walters said.

Australia’s economy is growing faster and generating more jobs than Treasurer Swan and Prime Minister Kevin Rudd forecast six months ago, helped by A$20 billion (RM61.61 billion) in government cash handouts to consumers and Stevens’s record interest-rate cuts between September 2008 and April, when he slashed the benchmark rate by 4.25 percentage points to a half- century low of 3%.

Unemployment is expected to peak at 6.75% in the second quarter of next year, well below the 8.5% rate Swan forecast in May for the three months through June 30, 2011, the government said on Nov 2.

The Nov 3 interest-rate increase will do nothing to resolve the nation’s housing shortage, said Housing Industry Association Chief Economist Harley Dale.

“It would be prudent for the Reserve Bank to sit on its hands,” Dale said.

The boost will add A$50 to monthly repayments on an average A$300,000 home loan. Australia & New Zealand Banking Group Ltd., Commonwealth Bank, National Australia Bank Ltd. and Westpac Banking Corp. raised their variable mortgage rates by a quarter point after the Nov 3 announcement.

“Today’s decision is a tough one for Australian families and businesses, but it’s also another indication that rates could not stay at 50-year emergency lows forever,” Swan told reporters in Brisbane on Nov 3.

Reports published in recent days show bank lending unexpectedly fell in September for the first time in nine months amid weaker demand for business credit, and manufacturing growth slowed in October.

“It looks like the Reserve Bank is doing the right thing,” billionaire Gerry Harvey, chairman of Australian retailer Harvey Norman Holdings Ltd., said in an interview.

“Those people who are looking at interest rates at 3.5% are saying to themselves it’s still low and my mortgage is still a lot less than I was paying before” Harvey said by telephone. “It shouldn’t have a great effect in the marketplace.” – Bloomberg LP
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