Australia Central Bank Steers Steady Course

Australia's central bank left interest rates unchanged at 6.25% on Wednesday, a decision widely expected given growing confidence among officials that past tightenings were working to restrain inflation.

The announcement came just a couple of hours before the government is expected to report the economy grew a lackluster 0.6% in the fourth quarter of 2006 as strength in domestic demand was eaten up by a widening trade deficit.

"This outcome was widely expected. In our view there is at least one more month of 'on hold' and most likely more, many more," said David de Garis, a senior economist at nabCapital.

The board of the Reserve Bank of Australia (RBA), which held its monthly rate setting meeting on Tuesday, does not comment on its reasoning when leaving policy unchanged.

Last month, the central bank trimmed its inflation forecast for this year and next, saying it was more confident that the current level of rates would be enough to keep inflation in its 2% to 3% target band.

But RBA Governor Glenn Stevens has also made it clear that price risks remained on the high side and interest rates were still more likely to rise than fall.

Yet, the recent slide in world equity markets and gathering speculation about a U.S. economic slowdown has seen the futures market toy with the idea of a rate cut later this year.

In just the past week, bank bill futures have swung from showing a moderate probability of a hike to pricing in a one-in-five chance of a rate cut by year-end.

It was timely then, that the head of the RBA's economics department, Malcolm Edey, was due to give a speech on the economic outlook for 2007 later on Wednesday.

Analysts said Edey, who is tipped as a possible future governor, would play down the volatility in global markets as a return to more prudent risk taking.

"We suspect the RBA is looking through this most recent episode, which may be harrowing for investors, but poses no great threat to central banks unless it creates a spiraling decline in confidence," said Cherelle Murphy, an economist at ANZ.

A Reuters survey of 23 economists taken last week found all expected rates to remain on hold in March, but there the equanimity ended. Thirteen thought the next move in rates could actually be down, while seven predicted a hike and an equal number saw policy on hold well over their forecasting horizon.

The steady rate view should be supported by the gross domestic product (GDP) report for the fourth quarter. The forecast 0.6% rise would be an improvement on the third-quarter's
pedestrian 0.3% increase, but would still see growth for the year slow to 2.0% from 2.2%.

Yet GDP is rather historical and more timely data have pointed to a quickening in activity. Surveys of business have been upbeat, vehicle sales rose to record levels for both January and February while retail spending and credit growth picked up.

Crucially, the labor market remains drum-tight with unemployment down at 30-year lows of 4.5% after employers created a stunning 300,000 new jobs in the past year.

"The RBA's main concern is the economy is running out of new workers," said Rory Robertson, interest rate strategist at Macquarie Bank. "It will only tighten again if unemployment falls yet further or we get some really bad news on inflation. Otherwise, they must be thrilled with where the economy is right now," he added.