Australia's Central Bank Warns of More Rate Rises

Australia's central bank bluntly warned on Monday that it would likely need to raise interest rates again to restrain inflation, even as it trimmed its outlook for economic growth.


The unusually explicit warning from the Reserve Bank of Australia (RBA) lifted the local dollar above 90 U.S. cents while bills futures slid as the market priced in a greater risk of a further rate hike, perhaps as soon as March.

"The RBA is on the warpath," said Rory Robertson, interest rate strategist at Macquarie. "It certainly highlights the fact they're thinking seriously about going again in March."

In its quarterly statement on monetary policy, the RBA said that, while past rate hikes and a slowdown in global growth could temper the red-hot economy, there was a risk rates were not high enough to ensure a significant moderation in domestic demand.

"On the current outlook and allowing for the inevitable uncertainties in forecasting, the risk of inflation remaining uncomfortably high for some time is considerable," the RBA said in its 56-page assessment of the economy.

"Absent a further shift in economic risks to the downside, therefore, monetary policy is likely to need to be tighter in the period ahead," warned RBA Governor Glenn Stevens.

Just last week the central bank bucked the global trend by lifting its benchmark cash rate by 25 basis points to an 11-year peak of 7.0 percent, a level it said was on the "restrictive side of neutral."

It cautioned then that the economy would have to cool significantly to restrain core inflation, which hit a 16-year high of 3.6 percent in the fourth quarter of 2007.

More Than One?

The market, though, had only priced in around a 30 percent chance of a move at the RBA's March meeting and had implied less than 10 basis points of tightening for the whole year.

That changed abruptly on Monday, with futures shifting to indicate a 57 percent probability of a hike in March. That would be the first back-to-back rate rise since 2003.

"We would not rule out a hike as soon as March and there's a clear danger rates will even have to rise past 7.25 percent," said Su-Lin Ong, a senior economist at RBC Capital Markets. "The RBA clearly has no more tolerance for upside surprises on inflation and are concerned about it feeding through to wage and price expectations," added Ong.

"The new inflation forecasts show they don't even get near their target until 2010, which leaves no room for policy errors."

The RBA lifted its forecast for underlying inflation for the year to June 2008 to an annual 3.75 percent, up sharply from 3.25 percent in its November statement and well above its 2 percent to 3 percent target band.

It now saw core inflation running at 3.5 percent by the end of 2008, before slowing gradually to 3.25 by the end of 2009. It predicted core inflation could remain around 3 percent through to mid-2010.

The upward revisions to inflation came even as it trimmed expectations for economic growth.

The RBA forecast gross domestic product (GDP) growth of 3.25 percent in the year to June 2008, off from 3.75 percent in the November statement. It saw growth of 3 percent for 2008/09, down from 3.5 percent previously.

But such a slowdown was clearly not enough for the RBA.

"Most importantly, if it is not reversed reasonably quickly the recent pick-up in inflation carries the risk of generating an upward drift in inflation expectations, which could feed back into wage- and price-setting behavior," the RBA warned.