Australia Unexpectedly Raises Rates; Currency Jumps

When Glen Stevens says "a possibility of a rate increase" he means it... The economists and I are 0-2 in the game of predicting the two most recent rate decisions. Luckily, I learned my lesson and did not trade around this.... If China is the Dog Australia is the Tail. PBC Hikes. Hence, RBA hikes.

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By Michael Heath - Nov 1, 2010 9:45 PM PT

(Bloomberg)--The Reserve Bank of Australia unexpectedly increased its benchmark interest rate on concern stronger growth will cause inflation to accelerate, driving the nation’s currency toward parity with the U.S. dollar. Governor Glenn Stevens raised the overnight cash rate target a quarter point to 4.75 percent in Sydney, saying the economy has “relatively modest amounts of spare capacity” and citing risk of “inflation rising again over the medium term.” It was the RBA’s first move in six months.

The move signals Stevens wants to avoid a repeat of 2007, when he held off raising rates for months as slowing inflation masked a buildup in price pressures. Growth in Australia, which skirted a recession during the crisis, may strengthen as energy companies such as BG Group Plc add construction jobs. “They’re trying to nip inflation in the bud,” Matthew Circosta, an economist at Moody’s Analytics in Sydney, said on Bloomberg Television. “Back in 2007 they were behind the curve” in raising rates and “I don’t think they want to make the same mistake this time around.”

The Australian dollar climbed to 99.71 U.S. cents as of 3:31 p.m. in Sydney from 98.82 cents before the announcement. The S&P/ASX 200 Index of stocks was little changed at 4,702.70.

Economists’ Forecasts

The decision, predicted by seven of 24 economists surveyed by Bloomberg News, was the second straight in which Stevens defied the majority of economists’ forecasts. Stevens’s move comes a day before the U.S. Federal Reserve meets to consider pumping additional stimulus into the world’s largest economy. The divergence in monetary policies has stoked the Australian dollar, which has gained about 11 percent this year against the U.S. currency.

Australia’s jobless rate, at 5.1 percent in September, is about half the level of unemployment in the U.S. and euro zone. The International Monetary Fund predicts Australia’s growth will advance to 3.5 percent next year from 3 percent this year as resources investment intensifies. “While the labor market is not as tight as in 2007 and 2008, some further strengthening would appear to be in prospect, judging by the trends in job vacancies,” the central bank said in today’s statement. “After the significant decline last year, growth in wages has picked up somewhat, as had been expected. Some further increase is likely over the coming year.”

End of ‘Moderation’

A “moderation” of inflation for the past two years “is probably now close to ending,” the RBA said. Two days ago, BG Group said it will begin building a $15 billion liquefied natural gas venture in Queensland state, generating 5,000 construction jobs. Investment there and in Western Australia, including Chevron Corp.’s A$43 billion ($42.5 billion) Gorgon liquefied natural gas project, is growing because of stronger Chinese demand for raw materials.

“The bank still sees Australian interest rates as likely to continue to rise as the mining boom progresses,” said Ivan Colhoun, head of Australian economics at Australia & New Zealand Banking Group Ltd. “This likely reflects the need to move nominal rates higher to match any rise in inflation and, at some stage, to also raise real interest rates too.” Today’s increase was announced half an hour before the running of the Melbourne Cup, dubbed “the race that stops the nation,” and means the central bank has moved borrowing costs in the past five meetings on the day of Australia’s richest horse race.

Banks’ Response

Borrowing costs at ANZ, Commonwealth Bank of Australia and Westpac Banking Corp. are under review, according to spokesmen at the lenders. National Australia Bank Ltd. spokesman George Wright said no decision has been made “at this stage.” Treasurer Wayne Swan has urged banks not to boost borrowing costs by more than any central bank increases. Australia lawmakers are sensitive about the RBA’s rate increases as more than two-thirds of the population own homes, compared with less than 50 percent in some European nations.

Australia’s central bank signaled after its Oct. 5 meeting that the decision to leave borrowing costs unchanged was “finely balanced” with the case for an increase, as a rising currency helped ease inflation concerns. Most economists had forecast a quarter percentage-point increase at that meeting.

Job Market

While the government’s consumer price index rose 0.7 percent from the second quarter, less than the 0.8 percent median estimate in a Bloomberg News survey, that may be shrouding intensifying price pressures. An Oct. 7 report showed the biggest back-to-back monthly job increases since 1988. The central bank’s measures of core inflation showed annual price increases also slowed last quarter. The bank aims to keep inflation in a range of 2 percent to 3 percent on average.

Stevens had paused after boosting borrowing costs in six quarter-point steps from October 2009 to May this year, the most aggressive round of rate increases among Group of 20 members. Companies such as BHP Billiton Ltd., Rio Tinto Group and BG, the U.K.’s third-largest oil and gas producer, have helped spur a hiring surge as they increase shipments of iron ore, coal and energy to China.

The growth in mining investment was a reason IMF staff last week said Australia is starting to exhibit “early signs” of inflation pressures. “With inflation projected to remain close to the top of the 2-3 percent target band, the RBA needs to guard against inflation expectations becoming anchored at too high a level,” the IMF staff said in an Oct. 29 report.

Among 33 members of the Paris-based Organization for Economic Cooperation and Development, Australia last year was the only advanced economy to avoid two consecutive quarters of contraction -- a standard definition of a recession -- along with developing economies Slovakia and Poland.

To contact the reporter for this story: Michael Heath in Sydney at mheath1@bloomberg.net;