Bank catches analysts on hop with hold on interest rates

SYDNEY - Australia's central bank unexpectedly paused in raising interest rates as Governor Glenn Stevens opted to support the economy's acceleration and stem inflation later.

The Reserve Bank of Australia kept the overnight cash rate target at 3.75 per cent after three increases.

The decision confounded the forecast of all 20 economists in a Bloomberg News survey for a quarter-point move, and futures contracts that signalled a 74 per cent chance of an increase.

Australia's dollar tumbled to a six-week low of US87.94c and Asian stocks pared gains after yesterday's announcement sparked concern at the economy's ability to withstand higher borrowing costs.

Business confidence fell to a six-month low, a report showed yesterday, and Woolworths, the country's biggest retailer, warned last week that rate increases would hurt consumers.

"The rapid adjustment process is over and the rate hikes, when they do come, will be further apart," said Matthew Johnson, an interest-rate strategist at UBS AG in Sydney. "The overarching message from the Reserve Bank is that while things are better than we thought, we're not out of the woods just yet."

As information about the impact of the bank's previous increases "is still limited, the board judged it appropriate to hold a steady setting of monetary policy for the time being", Stevens said.

Borrowing costs will be "adjusted further" to keep inflation within the central bank's target range of 2 per cent to 3 per cent "if economic conditions evolve broadly as expected", he said, adding that inflation should remain within the target this year.

Stevens became the first central banker in the world to raise borrowing costs three times last year after Australia's economy skirted the global recession, helped by A$20 billion ($25 billion) in cash handouts to consumers from Prime Minister Kevin Rudd and another A$22 billion in spending on roads, railways and schools.

By contrast, officials in the United States and Europe have kept benchmark lending rates at historic lows. The rate gap has contributed to making the Australian dollar the top performer against its US counterpart since the start of September among the most-traded currencies.

There are signs Stevens's rate increases in October, November and December are restraining the mortgage market.

Borrowing for home buying fell to a five-year low last month, according to a report by Australian Finance Group, which says it accounts for more than 10 per cent of the mortgage market. The group arranged A$1.55 billion of mortgages in January, 19 per cent less than a year earlier and the lowest level for any month since 2005.

Most mortgage rates have increased by about 1 percentage point since October, outpacing the central bank's 75 basis point increase in the benchmark rate, Stevens said.

"Three consecutive hikes late last year, coupled with out-of-cycle increases by commercial banks, appeared to have stung," said Prasad Patkar, who helps manage about A$1.5 billion at Platypus Asset Management in Sydney. Yesterday's decision "reduces the serious risk of a policy blunder. A pause is welcome".

ANZ boosted its variable mortgage rate by 35 basis points after Stevens raised the overnight cash rate target by 25 basis points on December 1.

Commonwealth Bank of Australia raised its home-loan rate by 37 basis points and Westpac Banking moved by the largest amount, driving up its mortgage rate by 45 basis points.

Westpac's move means households with a A$300,000 mortgage are being charged an extra A$1008 a year, instead of the A$576 that would have been imposed had the bank merely passed on the Reserve Bank's increases.

"Interest-rate rises are not good for consumers full stop," Michael Luscombe, chief executive of Woolworths, said last week.

"I think 2010 is going to be a challenging year."

Woolworths posted the slowest sales growth in a Christmas quarter since 1993. Consumer spending accounts for more than half of Australia's economy.

Households will "welcome this decision and businesses will welcome this decision", Treasurer Wayne Swan told Parliament in Canberra yesterday.

Business confidence fell in December to the lowest level in six months, a report by National Australia Bank showed. The bank's sentiment index dropped 11 points to 8.

- BLOOMBERG