Australia raises interest rates

Australia raises interest rates

By Peter Smith in Sydney

Published: February 5 2008 05:00 | Last updated: February 5 2008 05:52

Australia’s central bank blamed significant inflationary pressures for its decision on Tuesday to raise interest rates to their highest level in close to 12 years.

The 25 basis point rise in the benchmark cash rate to 7 per cent is the third increase in six months and comes despite aggressive cuts in US interest rates in recent weeks.

The Reserve Bank of Australia said underlying annualised inflation was around 3.5 per cent, above the upper end of its 2 to 3 per cent target, and higher than it expected a few months ago.

”The tough job of balancing the family budget just got a whole lot tougher today with the decision to increase interest rates,” Kevin Rudd, prime minister, said in reaction. ”After 10 interest rate rises in a row, this one will really hurt.”

The RBA said: “Indicators of demand remained strong through the second half of 2007, and reports of high capacity usage and shortages of suitable labour persist. In the short term, inflation is likely to remain relatively high.”

The central bank said it had noted “recent events abroad and developments in financial markets”.

Despite an expected slowdown in world economic growth in 2008, the bank forecast that Australia’s terms of trade would remain favourable thanks to buoyant commodity markets.

John Edwards, a senior economist at HSBC in Sydney, said: “There’s no doubt a 7 per cent cash rate… is formidable. Until we see evidence otherwise, we expect it to be the peak.”

Mr Rudd said the fight against inflation would take time. ”Inflationary pressures have taken a long time to build and they are going to take a long time to get back under control,” he said. “We have a really tough job ahead.”

Mr Edwards said the RBA does not expect annual inflation to begin to fall until 2009, adding the bank was otherwise uncommitted on its next rate move.

“Global growth is slowing, market interest rates have already increased and tightening of credit standards will continue,” Mr Edwards said. ”All those factors would suggest the 7 per cent cash rate is the peak.”

Mr Edwards said the only recent evidence of any significant slowing in the Australian economy came from Tuesday’s December building approvals number, which showed a sharp fall.

Australian interest rates are now at their highest level since July 1996. There have been 11 increases since 2001 when interest rates were at their low point of 4.25 per cent.

The central bank in December left rates unchanged, citing deteriorating sentiment in global credit markets and weaker growth prospects in major economies.

The RBA has also changed policy by making public its decision on interest rates the same day its board meets. Previously, the interest rate decision was announced the following day.

The RBA has also promised to provide commentary each month regardless of whether it lifts interest rates or not, whereas previously it did not comment if rates were left unchanged.