Australia's RBA Raises Rates, Warns on Inflation

Australia's central bank on Tuesday raised interest rates to a decade peak of 7 percent, as it struggled to keep inflation under control, and left the door open for even more hikes if the red-hot economy did not cool soon.


Following its monthly board meeting, the Reserve Bank of Australia (RBA) said it was lifting its key cash rate by 25 basis points because price pressures had grown markedly.

The central bank acknowledged the global credit crunch and fears of a U.S. recession could lead to sub-par world growth this year. Yet, RBA Governor Glenn Stevens emphasized that only a "significant slowing" in demand was likely to contain inflation.

"It certainly doesn't look to me like they're finished," said Stephen Halmarick, co-head of market economics at Citi. "They are focusing very much on the inflation risks, talking about
significant inflation pressures and needing to see a significant slowdown in domestic demand."

Core inflation in Australia accelerated to 3.6 percent last year, the fastest pace since 1991 and well above the central bank's 2-3 percent comfort zone.

The RBA's tough tone kept the Australian dollar firm around US$0.907, as investors pondered the likelihood that rates may have to rise again, perhaps in May after the next quarterly inflation report.

"At this stage we're looking at just under even money for a hike," said Joshua Williamson, a senior strategist at TD Securities. "But if the activity data remains strong and doesn't respond to this particular hike today, we could well see another rise before mid-year."

That outlook was in stark contrast with the United States where a housing slump was spilling across the economy, prompting the Federal Reserve to slash interest rates aggressively last month.

The Bank of England is also likely to ease policy when it meets later this week and even the European Central Bank is sounding more concerned about growth.

"It is unusual for the RBA to be hiking when other major central banks are cutting," said Rory Robertson, interest rate strategist at Macquarie. "But that's because our economy is stronger and our inflation pressures more intense. Which, in turn, is thanks to the growing economic power of China, driving our once-in-a-century commodity and terms-of-trade booms," he said.

Spending Spree

The resilience of the domestic economy was underlined by government data on Tuesday showing consumers went on a shopping spree last quarter. Retail sales for the fourth quarter jumped 1.6 percent to an inflation-adjusted A$57.59 billion ($52.4 billion), easily topping forecasts of a 1.1 percent rise.

That augured well for economic growth in the quarter, given retail sales account for around 23 percent of the country's annual output and the sector is the biggest single employer with about 15 percent of all jobs.

"There was a huge jump in sales volumes for the quarter which we reckon could add 0.4 percentage points to GDP (gross domestic product) all on its own," said Su-Lin Ong, a senior economist at RBC Capital Markets. "That sets Q4 up for brisk GDP growth on top of an already strong Q3."

The economy grew by 4.3 percent in the 12 months to September, the fastest pace in more than three years.

Neither was there much sign of frugality in January with vehicle sales climbing a seasonally adjusted 4.3 percent to a record high, according to industry data out on Tuesday.

But such unbridled spending was generating price pressures in an economy short of spare resources after 16 straight years of growth. Unemployment is near 33-year lows and firms complain endlessly of a lack of skilled labor.

Global demand was pushing food and fuel prices higher, while the cost of home-grown services from health to education were rising. Rents were also being squeezed up by rapid population growth and sluggish home building.

Data out on Tuesday showed approvals to build new homes dived 16 percent in December, with approvals for private houses dropping a sharp 11.6 percent.

"This is bad news for inflation, given rents are a key driving force at the moment," said Scott Haslem, chief economist at UBS.