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Australia's Central Bank Lifts Rates to 12-Year High
By: Reuters | 03 Mar 2008 | 11:39 PM ET
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Australia's central bank on Tuesday raised interest rates to a 12-year peak of 7.25 percent as it fought to keep inflation under control, but noted tentative signs the red-hot economy might be cooling.

Following its monthly board meeting, the Reserve Bank of Australia (RBA) said it was lifting its key cash rate by 25 basis points to contain inflation, which hit a 16-year high last quarter. That was the second rise in as many months and the 12th since this drawn-out tightening cycle began way back in 2002.

Yet, RBA Governor Glenn Stevens noted "tentative evidence" that household demand was moderating. He also acknowledged that past rate hikes coupled with rising borrowing costs from the global credit crunch had led to a "substantial" tightening in financial conditions.

"They've certainly highlighted that there's a lot of tightening of financial conditions in the system," said Stephen Halmarick, co-head of market economics at Citi. "I suspect that suggests they think they may be coming towards the end of the cycle."

Even a hint that an end to tightening might be near was enough to knock three-quarters of a U.S. cent off the Australian dollar [AUD-TN  Loading...      ()], while bond and bill futures rallied as the market trimmed the risk of a further move in May.

The odds of another hike had already lengthened earlier in the day after retail sales came in unchanged for January, a surprisingly soft result that may suggest spendthrift consumers are finally bowing to rising fuel and borrowing costs.

Key now will be the first-quarter inflation data due on April 23. Core inflation accelerated to 3.6 percent last year, well above the central bank's 2-3 percent comfort zone, and a further pick up is likely this quarter.

"The Reserve Bank seems to have given itself some breathing space in April, but the inflation report will still be ugly," said Joshua Williamson, senior strategist at TD Securities, arguing a rate rise to 7.5 percent in May remained likely.

What A Contrast

The RBA's tightening is in stark contrast to many other major central banks which are busy cutting rates to cushion their economies from the shockwaves of the U.S. subprime mess.

The Bank of Canada, for instance, is widely expected to ease later on Tuesday as economic growth there braked to its slowest pace in four years last quarter.

Yet Australia's gross domestic product (GDP) report due on Wednesday is expected to show annual economic growth was still a robust 3.6 percent in the fourth quarter of last year, well above what the RBA considers compatible with a slowdown in inflation.

Indeed, the central bank is concerned that huge price rises this year for iron ore and coal, Australia's two most valuable exports, will deliver another big windfall for incomes in the economy, keeping demand aflame.

The government's bureau of agriculture on Tuesday forecast export earnings from commodities would jump by almost a third in the year to June 2009, hitting a record A$189 billion. That should help narrow the country's current account deficit, which blew out to a record A$19.35 billion last quarter.

Still, analysts caution that the global financial squeeze has sharply raised funding costs for banks and companies in Australia, and could even lead to banks rationing credit.

"The RBA has a tough job to assess the net effect of two extraordinary things," said Rory Robertson, an interest rate strategist at Macquarie. "The biggest commodity-price boom in Australia's history alongside the slow-moving, self-reinforcing 'train wreck' that is the global credit crunch.

"The risk is that the global shift to risk aversion and de-leveraging is generating a market-based tightening of financial conditions that could crunch demand much more than actually desired," he warned.

Copyright 2009 Reuters. Click for restrictions.
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