Australia's Central Bank Lifts Rates to 11-Year High

Australia's central bank raised interest rates to an 11-year high on Wednesday as it battled to contain inflation, a decision charged with unusual political implications just two weeks before a national election.

In a widely anticipated move, the Reserve Bank of Australia (RBA) lifted its key cash rate a quarter of a percentage point to 6.75 percent, the second hike in four months and the 10th in a tightening cycle that began in mid-2002.

The Australian dollar climbed above 93 U.S. cents while bond futures eased as investors were already pondering the prospect of a further hike, perhaps as early as December.

"We continue to see another move to 7 percent," said Stephen Halmarick, co-head of market economics at Citi. "Our base case for another rise is February after the consumer price index
but I wouldn't rule out one as early as December," he added.

Investors seemed to agree, with the futures market showing around a 30 percent chance of a move in December but fully priced for 7.0 percent by March. In all, no less than 41 basis points of further tightening is foreseen in the next 12 months.

In a brief statement explaining the move, RBA Governor Glenn Stevens warned that inflation would likely be above the top of the central bank's 2 to 3 percent comfort zone by the first quarter of 2008.

The RBA's key measure of core inflation had already accelerated to 3 percent in the third quarter, and analysts suspected a further pick up was likely this quarter.

The central bank noted domestic demand had strengthened since its previous hike in August and there were few signs of a moderation as yet. The high Australian dollar would help restrain price pressures somewhat, it added.

"But growth in aggregate demand will, nonetheless, need to moderate if inflation is to be kept to 2-3 percent in the medium term," Stevens said.


"It's pretty hawkish commentary," said Stephen Walters, chief economist at JPMorgan. "We're forecasting another move in February, but there is a risk of December," he added. "On these comments, you can't say that 7.0 percent would be the peak, the risk is they have to go more than that."

Wednesday's hike, the first ever during an election campaign, is a blow to the Liberal National coalition government as it trails the opposition Labor Party in the polls. Rising mortgage rates are a sensitive topic in a country where 70 percent of households own their homes and debt is at record levels.

There had been thoughts the central bank might be reluctant to tighten at such a politically sensitive time, but the sheer strength of the economy put that to rest.

Recent figures have shown businesses borrowing at a furious pace, housing construction turning for the better and consumers spending up a storm. Global commodity prices have also reached new highs, delivering a huge windfall to incomes in Australia's massive resources sector.

As a result analysts have been revising up their estimates for third-quarter economic growth to 1.0 percent or more -- a result which would lift the annual pace toward 5 percent.

"They really want to see signs that aggregate demand is moderating before they can be confident that inflation's going to be back in the band," said Kieran Davies, chief economist at ABN AMRO. "It suggests that they've got the tightening bias and that they'd be considering a follow-up hike."