By Sarah Turner, MarketWatch
SYDNEY (MarketWatch) — Australia’s central bank lifted its benchmark cash rate by a quarter-point Tuesday, citing inflation risks and surprising a market that had put a low probability on the chance of a hike.
The Reserve Bank of Australia added 25 basis points to the rate, bringing it to 4.75%. It was the RBA’s first such rate increase since May.
The Australian dollar surged after the move, and bank shares also strengthened, with the Commonwealth Bank of Australia lifting its mortgage rate shortly after the decision.
Reuters
In a statement accompanying the RBA decision, Gov. Glenn Stevens said: ”At today’s meeting, the board concluded that the balance of risks had shifted to the point where an early, modest tightening of monetary policy was prudent.”
“Concerns about the possibility of a larger-than-expected slowing in Chinese growth have lessened recently, and most commodity prices have firmed, after a fall earlier in the year. The prices most important to Australia remain at very high levels, with the result that the terms of trade are at their highest since the early 1950s,” the RBA said.
Earlier Tuesday, the market had been pricing in a 28% chance of a quarter-point rate hike, according to Credit Suisse research.
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Expectations for a hike had been watered down after a tame quarterly consumer-price reading last month. But the RBA said that it remains concerned about inflation “notwithstanding recent good results.” It said ”the risk of inflation rising again over the medium term remains.”
Royal Bank of Canada strategists said that the fact that the RBA is looking ahead to the medium-term means that it has “learned numerous lessons from the last terms-of-trade boom in 2006-08, where it probably waited too long to tighten further and was forced to scramble and hike several times in 2007-08.”
They said the RBA move “signals a shift into the second phase of the tightening into modestly restrictive territory.”
The central bank lifted rates despite a sharp rise in the Australian dollar, which recently hit highs not seen for more than 20 years. The currency is expected to “assist, at the margin” in containing inflation, the RBA said.
The Australian dollar /quotes/zigman/4867876/sampled AUDUSD -0.0091% strengthened after the RBA decision, rising 1.3% to 99.76 U.S. cents and once again approaching parity with the greenback.
Credit Agricole strategists said that they believe that the Australian dollar will hold around this level and may struggle to rise much further against the greenback in the short term.
“The wording of the statement doesn’t sound as though the move is the beginning of another run of quick rate hikes,” they said.
Still, high terms of trade and modest spare capacity will contribute to the need for tightening further down the line, they said, “and we look for further hikes, with at least another 25-basis-point move in the first quarter of 2011.”
The hike from the RBA also heightened the possibility of consequent interest-rate increases from all four of Australia’s top retail banks, with the Commonwealth Bank of Australia saying shortly after the decision that it would hike its mortgage rates.
The issue of retail-bank rate hikes is a controversial one in Australia, as the senate last week launched a inquiry into some aspects of the banking sector, including funding costs and the availability of competition in a sector dominated by four large banks.
Treasurer Wayne Swan hit out at the Commonwealth Bank’s decision to lift rates, calling it “a cynical cash grab” and promised to make the system more competitive.
“There needs to be a change of attitude at the top of some of our banks,” he said at a press conference after the RBA decision.
Banking shares trader higher Tuesday, with Commonwealth Bank of Australia /quotes/zigman/181773 AU:CBA -1.40% /quotes/zigman/181772/quotes/nls/cbauf CBAUF +2.87% shares closing up 1.8%, and Westpac Banking Corp. /quotes/zigman/181294 AU:WBC -0.44% /quotes/zigman/181293/quotes/nls/webnf WEBNF -0.39% — which reports fiscal-year results Wednesday — closing 1.1% higher.