Bank of Australia surprises with rate rise

Wayne Cole, Reuters SYDNEY - Australia’s central bank surprised markets by raising its key cash rate to a two-year high of 4.75% on Tuesday, saying a modest tightening was needed as a pre-emptive strike against inflation.

The local dollar shot a cent higher after the Reserve Bank of Australia (RBA) lifted rates by 25 basis points at its monthly policy meeting. The central bank had already led the developed world in hiking 150 basis points between October and May.

“The board concluded that the balance of risks had shifted to the point where an early, modest tightening of monetary policy was prudent,” RBA Governor Glenn Stevens said in a statement.

Many investors had thought the central bank would skip a hike for a sixth straight month, given data out last week had shown core inflation had moderated to 2.5%, in the middle of the RBA’s long-term target band of 2 to 3%.

The move also stood in sharp contrast to loose policy in major developed nations and comes just a day before the Federal Reserve is expected to announce a fresh phase of quantitative easing in the face of unbearably high unemployment.

Yet Mr. Stevens said surging export earnings and a lack of spare capacity in the economy meant inflation risks ahead were to the upside, no matter the recent benign outcome. Analysts took this to mean further moves ahead, though likely not until February. Interbank futures fell sharply across the curve but showed only a one-in-10 chance of a move next month. The RBA board does not meet in January.

“The Reserve Bank’s capacity to surprise continues,” said Michael Blythe, chief economist at Commonwealth Bank. “At this stage we’ve got the next hike pencilled in for February and we’ve got the cash rate at 5.75% by the end of 2011.”

The pace of official tightening could be slowed by leading home lender Commonwealth Bank of Australia’s decision to raise its own mortgage rate by 45 basis points. Other major lenders are considered likely to follow, citing higher funding costs.

Mortgage rates have a big impact on spending power in a nation obsessed with home ownership and where over 90% of home loans are on floating rates.

“We’ll still get another four hikes next year, that hasn’t changed,” said Stephen Walters, chief economist at JPMorgan.