Reserve Bank's Australia rate rise surprises market

The aussie climbed to US99.96c after the quarter per cent increase was announced by the Reserve Bank of Australia. Photo / Getty Images

The Reserve Bank of Australia unexpectedly increased its benchmark interest rate yesterday on concern stronger growth will cause inflation to accelerate, driving the nation's currency toward parity with the US dollar.

Governor Glenn Stevens and his board raised the overnight cash rate target by a quarter percentage point to 4.75 per cent, the first move in six months.

Australia's economy "is now subject to a large expansionary shock" from trade and "relatively modest amounts of spare capacity," and the risk of "inflation rising again over the medium term remains", it said.

Growth in Australia, the only developed economy to skirt last year's global recession, is forecast to strengthen next year as energy companies such as BG Group add construction jobs.

By raising borrowing costs, Stevens may be looking to history as a guide after a report last week showed a smaller-than-projected gain in consumer prices in the third quarter.

"They're trying to nip inflation in the bud," said Matthew Circosta, an economist at Moody's Analytics in Sydney. "Back in 2007 they were behind the curve in raising rates and I don't think they want to make the same mistake this time around."

The Australian dollar climbed to US99.96c last night.

The decision, predicted by seven of 24 economists surveyed by Bloomberg News, was the second straight in which Stevens defied the majority of economists' forecasts.

Stevens' move came a day before the US Federal Reserve meets to consider pumping additional stimulus into the world's largest economy.

The divergence in monetary policies has stoked the Australian dollar, which has gained about 11 per cent this year against the US currency.

Australia's jobless rate, at 5.1 per cent in September, is about half the level of unemployment in the US and euro zone.

The International Monetary Fund predicts Australia's growth will advance to 3.5 per cent next year from 3 per cent this year as resources investment intensifies.

Two days ago, BG Group said it would begin building a A$15 billion ($19.5 billion) liquefied natural gas venture in Queensland state, generating 5000 construction jobs.

Investment there and in Western Australia, including Chevron's A$43 billion ($56 billion) Gorgon liquefied natural gas project, is growing because of stronger Chinese demand for raw materials.

Yesterday's increase was announced half an hour before the running of the Melbourne Cup, dubbed "the race that stops the nation", and means the central bank has moved borrowing costs in the past five meetings on the day of Australia's richest horse race.

Prime Minister Julia Gillard warned last month that the nation's dependence on commodities needs to be reduced to broaden a "patchwork economy", where regions exposed to the resources boom grow while others trail behind. The Government is proposing a levy on profits from iron ore and coal mines that will allow it to reduce corporate taxes.

Australia's central bank signalled after its October 5 meeting that the decision to leave borrowing costs unchanged was "finely balanced" with the case for an increase, as a rising currency helped ease inflation concerns.

Most economists had forecast a quarter percentage-point increase at that meeting.

The Australian dollar surged toward parity with the US currency after an October 7 report showed the biggest back-to-back monthly job increases since 1988. It fell 1.4 per cent on October 27 following the inflation data.

That report showed the consumer price index rose 0.7 per cent from the second quarter, less than the 0.8 per cent median estimate in a Bloomberg News survey of 24 economists.

The central bank's measures of core inflation showed annual price increases also slowed last quarter.

The bank aims to keep inflation in a range of 2 per cent to 3 per cent on average.

Stevens boosted borrowing costs in six quarter-point steps from October 2009 to May this year, the most aggressive round of rate increases among Group of 20 members.

- BLOOMBERG