Aussie Rate Hike Just The Beginning

October 6, 2009

The 25-basis point hike in the Reserve Bank’s cash rate to 3.25% is first increase since March 2008 and ends a streak of six cuts between September 2008 and April 2009 totaling 425 basis points.  That very sharp rate decline to a 49-year low braced for what officials expected to be “a serious economic contraction in Australia,” according to a statement released by monetary officials today.  The passing of such a risk has passed, justifying today’s “prudent” step “to begin gradually lessening the stimulus provided by monetary policy.”  Thus, Australia joins the Bank of Israel as only the second central bank to tighten following the global financial crisis and the first Group of Twenty central bank to do so.

The statement notes that today’s rate hike was made after the Board “carefully considered” the sharp appreciation of the Australian dollar, which will constrain imported inflation and growth in some tradable goods sectors.  Nonetheless, officials expected underlying inflation to bottom out at a higher level than assumed previously because of a higher economic growth profile.  The Bank’s latest forecasts had penciled in GDP growth of 2.25% next year and 3.75% in 2011, and today’s statement characterized future growth as probably “close to trend.”

On the matter of economic growth, note is made that many governments are retaining expansionary macro-economic policy settings, that conditions in Australia have developed more strongly than expected, that confidence is recovering, that private investment in particular is positioned for revival, that housing and public infrastructure are perking up too, and that “large firms have had good access to equity capital and access to debt markets appears to be improving.”  Most of all, Australia is benefiting from brisk Chinese demand, which elevates commodity prices and is a source of direct bidding for Australian exports.

Now that the Reserve Bank has begun tightening while other central bank policy stances are likely to stay on hold for some time longer, the way would seem clear for a further climb of the Aussie dollar to and above 90 U.S. cents.  Today’s response was exaggerated because despite strong expectations of a hike before yearend, most analysts seems to have been caught on the wrong side of the fence regarding today’s action.  Traders were thus unprepared for today’s move and its juxtaposition against rumors of OPEC plans to abandon dollar pricing over then next decade.

Copyright Larry Greenberg 2009.  All rights reserved.  No secondary distribution without express permission.

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