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Reserve Bank of Australia Holds Rates Amid Credit Pain

Reuters
Tuesday, 2 Oct 2007 | 8:27 PM ET

Australia's central bank held interest rates steady as expected on Wednesday, likely waiting for global credit turmoil to calm and for a critical update on domestic inflation before deciding whether to hike again.

The Reserve Bank of Australia (RBA), which held its monthly policy meeting on Tuesday, makes no comment on its reasoning when leaving rates steady. It raised rates to a decade high of 6.5 percent in August, trying to cool an overheating economy.

Since then, domestic economic news has gone from strength to strength, leading many analysts to suspect rates will eventually have to be lifted again. But for now, the global outlook has been clouded enough by the housing-driven downturn in the United States that discretion was warranted.

"Rates may have been left steady this month, but there are no guarantees about next month or the month after," said Craig James, chief equities economist at CommSec. "The Reserve Bank is engaged in an on-going battle with inflation and is certainly not about to declare victory any time soon."

The steady decision had been well discounted by the market and had little impact on the dollar or bonds.

Still, the squeeze in global credit markets has also seen some smaller institutions in Australia raise borrowing costs for households and business.

Just the day before, mortgage lender RAMS Home Loans lifted its variable rates and was forced to sell its brand to a major bank to obtain vital financing.

This tightening in credit has essentially done some of the central bank's work for it, lessening the need for a hike in official rates.

In a speech last month, RBA Governor Glenn Stevens welcomed the extra restraint from higher market rates, saying the economy was still running hot enough to ignite inflation.

Yet since then market rates have eased somewhat as the worst of the global dislocation seemed to be past. Local interbank rates have drifted back to 6.88%, from peaks above 7.10% in August.

Matthew Johnson, a senior economist at broker ICAP, also noted that the RBA had been draining excess funds from the banking system, suggesting confidence was returning.

"Ironically, the more things stabilize the more risk there is the RBA will have to lift rates itself," said Johnson. "The obvious punt is that the market is not aggressively enough priced for RBA action.

Indeed, a Reuters poll of 22 economists last week found a majority expected another tightening, putting a median probability of 60% on a move. Most thought the central bank would hold off until the first quarter of next year but cautioned that much depended on coming inflation figures.

The consumer price index (CPI) is due on Oct. 24 and any repeat of the previous quarter's sharp 1.2% increase could compel the RBA to act.

"The stretched nature of the economy in both goods and labor markets, and upward pressure on food prices, rents, and petrol point to another likely firm print for underlying inflation,' said Su-Lin Ong, a senior economist at RBC Capital Markets.

"While we think global uncertainty dominates for now, the RBA could forced to move by a poor inflation report."