Cash-rate rise reflects strong economy

SYDNEY - Australia's central bank resumed raising interest rates after a one-meeting pause yesterday, judging that the economy is strong enough to withstand any impact from global investor concerns on sovereign debt risks.

Reserve Bank Governor Glenn Stevens increased the benchmark overnight cash rate target to 4 per cent from 3.75 per cent in Sydney. The decision may support Australia's dollar, the best-performing major currency in the past year, and reflects the strength of an economy that escaped recession during the global crisis.

The biggest jobs boom in more than three years, a jump in house prices and a business-confidence rebound put pressure on Stevens to return rates towards what he calls a "normal" level.

"The economy is recovering with much less slack than in past upswings," Kieran Davies, a senior economist at Royal Bank of Scotland Group in Sydney, said ahead of yesterday's decision.

"The immense mining-led strength of the outlook for business investment should also reinforce the Reserve Bank's view that China will support growth in Australia despite ongoing troubles in Europe."

Stevens said interest rates to most borrowers "remain lower than average".

"The board judges that with growth likely to be close to trend, and inflation close to target over the coming year, it is appropriate for interest rates to be closer to average. Today's decision is a further step in that process."

Yesterday's increase by the Reserve Bank widens the gap between Australia's cash rate target and the US benchmark to 3.75 percentage points, the most since January 2009.

The difference between the Australian and UK benchmarks is now 350 basis points, the widest since 1990.

The announcement came hours after the Government reported retail sales climbed 1.2 per cent in January from December, exceeding the forecasts of all 19 economists in a Bloomberg News survey.

A separate report showed home-building approvals fell in January, affected by the Reserve Bank's rate increases and a reduction in government grants to first-time buyers.

Evidence of an accelerating expansion convinced most economists to predict yesterday's move after a majority in the Bloomberg News survey on February 12 saw no change.

Sovereign debt concerns have caused the euro to tumble since the start of the year and emerging stock markets to retreat.

Yesterday's move makes Stevens the first central banker from a Group of 20 economy to boost benchmark rates this year, after leading the way in presiding over three moves last quarter.

The increases brought the rate up from a half-century low of 3 per cent.

Pressure is also mounting on central banks in Canada, India, Malaysia and Indonesia to lift borrowing costs soon. Malaysia's economy grew a greater-than-forecast 4.5 per cent last quarter from a year earlier, and a report on Monday showed Indonesia's inflation was at a nine-month high. Canada's expansion is the fastest since 2000, a report showed late on Monday.

By contrast, US Federal Reserve Chairman Ben Bernanke said last week the world's largest economy is in a "nascent" recovery that still requires low rates. The Fed has kept its benchmark close to zero since late 2008. The European Central Bank's rate is at a record low of 1 per cent.

Australia's economy probably grew the most in 1 years in the fourth quarter, boosted by A$22 billion ($20 billion) in spending by Prime Minister Kevin Rudd on roads and schools.

Gross domestic product rose 0.9 per cent in the fourth quarter from the previous three months, when it gained 0.2 per cent, according to the median estimate of 18 economists surveyed by Bloomberg. The figures will be released today.

GDP growth would quicken to an annual pace of 3.25 per cent in the fourth quarter from 2 per cent late last year, the Reserve Bank said in February.

"I argued in February that the Reserve Bank would be unable to pause for any length of time in the face of strong economic data," said Adam Carr, a senior economist at ICAP Australia in Sydney.

"Stock markets over the past week have generally been more buoyant, and the news flow less pessimistic than February."

A month ago, Governor Stevens cited concern about sovereign debt in Europe and turmoil on financial markets for keeping the benchmark rate unchanged.

Reports published since then suggest inflation pressures may strengthen as a rising skills shortage boosts wages.

Employers added 194,600 jobs in the five months through January, the most in more than three years, cutting the unemployment rate to an 11-month low of 5.3 per cent.

Business investment jumped in the fourth quarter at almost three times the pace predicted by analysts as companies raised forecasts for investment plans to a five-year high, a report showed last week.

- BLOOMBERG