Australia's Central Bank Holds Rates Steady at 6.25%

Australia's central bank kept interest rates steady at 6.25% on Wednesday, as slowing inflation gave it scope to skip a tightening despite strong domestic demand and a drum-tight labor market.

The Australian dollar held steady while bond futures were a shade softer after the Reserve Bank of Australia's (RBA) widely expected decision.

The central bank held its monthly policy meeting on Tuesday and financial markets had priced in scant chance of a hike given surprisingly benign inflation figures out last week.

"The inflation data were really comforting for the central bank, showing the lowest unemployment in a generation still wasn't generating price pressures," said Rory Robertson, interest rate strategist at Macquarie Bank.

"That means the RBA is firmly on hold until it sees a disturbing inflation development -- and we don't get inflation figures until late July," he added. "Remember, the RBA has never been in a hurry to tighten, it's hiked eight times in five years."

The central bank raised rates three times last year to restrain price pressures, and the tap on the brakes seemed to be bearing fruit as inflation slowed last quarter.

The annual pace of underlying inflation dropped to 2.7% in the first quarter, from 3.0% the previous quarter, leaving it well within the RBA's 2% to 3% target range. Inflation was also likely to slow further in the current quarter as large rises from last year dropped out of the calculation.

No Spare Capacity

The central bank does not comment on its reasoning when leaving rates unchanged, but will provide a 60-odd page assessment of the economy in its Quarterly Statement on Monetary Policy on Friday.

Analysts assume it will highlight recent signs of an acceleration in demand and the general lack of spare capacity in the economy after 16 years of ceaseless growth.

"The statement probably will signal that the risks to the cash rate remain skewed to the upside, but that the urgency for higher rates has diminished," said Stephen Walters, chief economist at JPMorgan.

Some saw a chance the RBA could further lower its forecasts for inflation. In its last statement, the central bank forecast underlying inflation of 2.75% over the current year and a range of 2.5 to 3.0% for 2008.

However, such a move could be taken as an "all-clear" on rates and encourage Australia's already heavily indebted households to borrow even more.

"Lowering the inflation forecast would signal that the RBA's tightening cycle is over," said Walters. "This is not the signal RBA officials want to send with the economy still operating at close to full capacity."

Yet actually acting on a tightening bias could prove problematical as the year progresses, given a general election is likely in October or November.

RBA Governor Glenn Stevens has said he would not hesitate to tighten before an election should the economic evidence warrant it, but analysts have their doubts.

"Given that the RBA does not operate in a political vacuum, we think that the data would have to mount a compelling case for action," said Kieran Davies, chief economist at ABN Amro.