Reserve Bank of Australia surprises most with 25 bps hike in cash rate (Update 1)

The Reserve Bank of Australia (RBA) has surprised 19 out of 20 Australian economists by increasing its official cash rate by 25 basis points to 3.25%. It is the first major developed economy to hike its cash rate since the financial crisis triggered mass officials rate cuts from mid-2008. (Update 1 includes more detail from RBA statement and foreign exchange reaction) "In late 2008 and early 2009, the cash rate was lowered quickly, to a very low level, in expectation of very weak economic conditions and a recognition that considerable downside risks existed," RBA Governor Glenn Stevens said in a statement from the central bank. "That basis for such a low interest rate setting has now passed, however. With growth likely to be close to trend over the year ahead, inflation close to target and the risk of serious economic contraction in Australia now having passed, the Board's view is that it is now prudent to begin gradually lessening the stimulus provided by monetary policy," Stevens said. "This will work to increase the sustainability of growth in economic activity and keep inflation consistent with the target over the years ahead." The Reserve Bank of New Zealand will be watching closely ahead of its own cash rate decision on October 29, although economists here expect Governor Alan Bollard to leave our OCR on hold at a record low of 2.5% until next year. The widening gap is seen by some as weakening the New Zealand dollar against the Australian dollar, although that has not happened in recent days as speculation grew that the RBA may hike. The New Zealand actually jumped half a cent against the Australian dollar to be trading near 84 cents in late trade on Tuesday. The Kiwi dollar also jumped to 73.5 UScents in late trade. Here is the full statement below. See more here at our sister site www.interestratenews.com.au.

At its meeting today, the Board decided to raise the cash rate by 25 basis points to 3.25 per cent, effective 7 October 2009. The global economy is resuming growth. With economic policy settings likely to remain expansionary for some time, the recovery will likely continue during 2010 and forecasts are being revised higher. The expansion is generally expected to be modest in the major countries, due to the continuing legacy of the financial crisis. Prospects for Australia's Asian trading partners appear to be noticeably better. Growth in China has been very strong, which is having a significant impact on other economies in the region and on commodity markets. For Australia's trading partner group, growth in 2010 is likely to be close to trend. Sentiment in global financial markets has continued to improve. Nonetheless, the state of balance sheets in some major countries remains a potential constraint on their expansion. Economic conditions in Australia have been stronger than expected and measures of confidence have recovered. Some spending has probably been brought forward by the various policy initiatives. As those effects diminish, these areas of demand may soften somewhat. Some types of capital spending are likely to be held back for a while by financing constraints, but it now appears that private investment will not be as weak as earlier expected. Medium-term prospects for investment appear, moreover, to be strengthening. Higher dwelling activity and public infrastructure spending is also starting to provide more support to spending. Overall, growth through 2010 looks likely to be close to trend. Unemployment has not risen as far as had been expected. The weaker demand for labour over the past year or so nonetheless has seen a moderation in labour costs. Helped by this and the earlier fall in energy and commodity prices, inflation has been declining, though measures of underlying inflation remained higher than the target on the latest reading. Underlying inflation should continue to moderate in the near term, but now will probably not fall as far as earlier thought. Housing credit growth has been solid and dwelling prices have risen appreciably over the past six months. Business borrowing has been declining, as companies have sought to reduce leverage in an environment of tighter lending standards. But large firms have had good access to equity capital and access to debt markets appears to be improving, helped by the better-than-expected economic conditions and increased willingness on the part of investors to accept risk. Share markets have recovered significant ground. Interest rates facing prospective borrowers on fixed-rate loans have already risen to some extent, as markets have anticipated a higher level of the cash rate. For many business borrowers, increases in risk margins will still be occurring for some time yet. In addition, the exchange rate has appreciated considerably over the past year, which will dampen pressure on prices and constrain growth in the tradeables sector. These factors have been carefully considered by the Board. In late 2008 and early 2009, the cash rate was lowered quickly, to a very low level, in expectation of very weak economic conditions and a recognition that considerable downside risks existed. That basis for such a low interest rate setting has now passed, however. With growth likely to be close to trend over the year ahead, inflation close to target and the risk of serious economic contraction in Australia now having passed, the Board's view is that it is now prudent to begin gradually lessening the stimulus provided by monetary policy. This will work to increase the sustainability of growth in economic activity and keep inflation consistent with the target over the years ahead.