Australia first to raise interest rates twice

Australia raised its benchmark interest rate by a quarter percentage point for the second time in four weeks, becoming the first nation to increase borrowing costs twice this year as the global economy recovers.

Reserve Bank Governor Glenn Stevens increased the overnight cash rate target to 3.5 percent from 3.25 percent in Sydney Tuesday, as forecast by 18 of 22 economists surveyed by Bloomberg News. The rest expected a half-point increase. The currency fell after today`s decision.

Economic growth in Australia, which side-stepped the global recession, will be `close to trend` over the year ahead, allowing policy makers to `gradually` increase rates, Stevens said. Treasurer Wayne Swan said yesterday the economy will expand faster than he previously forecast, driven by surging consumer confidence and Chinese demand for iron ore and coal.

"There is a hint of a pause," in today`s statement, said Annette Beacher, senior strategist at TD Securities in Singapore. Policy makers "recognized that the exchange rate will dampen the tradable sector, and dampen price pressures. There could be a pause in December."

The Australian dollar fell to 90.40 U.S. cents at 2:43 p.m. in Sydney from 90.88 cents just before the decision was released, as traders pared bets on the pace of future rate increases. The two-year government bond yield fell 14 basis points to 4.59 percent. A basis point is 0.01 percentage point.

"The adjustments at the October and November meetings will work to increase the sustainability of growth in economic activity and keep inflation consistent with the target over the years ahead," Stevens said Tuesday.

The 29 percent gain the currency this year "is likely to constrain output in the tradeables sector and dampen price pressures," he said.

Investors, hungry for China`s economic growth, have been betting the Australian dollar is headed toward parity with the U.S. currency for the first time, buying into the world`s biggest exporter of iron ore used in making steel.

Citigroup Inc., Calyon, Barclays Capital and National Australia Bank Ltd. forecast it will trade at 1 U.S. dollar next year, implying an additional 11 percent gain. Hedge funds and other large traders have more bets than any time since July 15, 2008, that the rally will continue, data from the Washington- based Commodity Futures Trading Commission show.

Stevens also raised the rate by a quarter point on Oct. 6. The only other countries to increase borrowing costs this year are Israel and Norway. By contrast, the U.S. Federal Reserve has kept its benchmark rate close to zero for almost a year. The European Central Bank and Bank of England benchmark rates are at record lows of 1 percent and 0.5 percent respectively.

Australian policy makers have signaled they`re prepared to keep raising borrowing costs and tolerate further appreciation in the nation`s currency, the best-performing in the past 12 months of 171 currencies tracked by Bloomberg, as it `may help contain inflation.`

The central bank`s measure of core inflation, the so-called weighted median index of consumer prices, rose 3.8 percent in the third quarter from a year earlier, holding above the top of Governor Stevens`s target range of between 2 percent and 3 percent for a ninth straight quarter, a report showed on Oct. 28.

Australia`s economy is growing faster and generating more jobs than Treasurer Swan and Prime Minister Kevin Rudd forecast six months ago, helped by A$20 billion ($18 billion) in government cash handouts to consumers and Stevens`s record interest-rate cuts between September 2008 and April, when he slashed the benchmark rate by 4.25 percentage points to a half-century low of 3 percent.

Gross domestic product will expand 1.5 percent in the 12 months to June 30, 2010, Treasurer Swan said yesterday after scrapping his May prediction of a 0.5 percent contraction. GDP will accelerate to 2.75 percent the following fiscal year, he said. The economy grew 1 percent in the first six months of this year.

Unemployment is also expected to peak at 6.75 percent in the second quarter of next year, well below the 8.5 percent rate Swan forecast in May for the three months through June 30, 2011.

Higher rates shouldn`t pose a threat to consumer spending, said Bernie Brookes, chief executive officer of Myer Holdings Ltd., an Australian department store chain whose stocks traded for the first time yesterday.

"Most people realize that the interest rate we`ve had has been an emergency interest rate, so people expect interest rate rises to control inflation in the economy," he said, according to the Australian newspaper.

"The Australian economy has turned out to be quite a lot stronger than we thought," Reserve Bank Assistant Governor Philip Lowe said last month. "It`s entirely appropriate we go back to a more normal setting in monetary policy. And that`s the process that`s under way."

There are also signs of a surge in some asset prices. A report yesterday showed house prices jumped 8.4 percent in the six months through September. The nation`s benchmark S & P/ASX 200 index of stocks has climbed more than 20 percent this year.

Today`s increase will add A$50 to monthly repayments on an average A$300,000 home loan.

How the increase affects "consumers will be critical to the flow-on impact on domestic demand and housing markets," Matthew Hassan, a senior economist at Westpac Banking Corp., said ahead of the decision.

"Interest rates are coming from all-time lows, but household debt is at record highs," he added. "This argues strongly for a more cautious tightening from the central bank."

Reports published in recent days show bank lending unexpectedly fell in September for the first time in nine months amid weaker demand for business credit, and manufacturing growth slowed in October.

Stevens should have waited longer before raising borrowing costs this year because the economy is "still fragile," Mike Smith, head of Australia & New Zealand Banking Group Ltd, said last week. "It wouldn`t have been a bad idea just to let Christmas wash through and then see what needed to happen in the new year," he said Oct. 29.

The Reserve Bank, which scrapped its forecast in August for the economy to contract this year, will publish revised predictions on Nov. 6. Its most recent estimate was for GDP to expand 2.25 percent in 2010 and 3.75 percent in 2011. (Bloomberg)