Australian Central Bank May Raise Rates Before Poll (Update1)

By Gemma Daley and Victoria Batchelor

Nov. 5 (Bloomberg) -- Glenn Stevens may become the first Australian central bank governor to raise interest rates in the midst of an election campaign, a move that may dent Prime Minister John Howard's chance of winning a fifth term in office.

Stevens will increase the overnight cash rate target a quarter point to 6.75 percent on Nov. 7, less than three weeks before Australians go to the polls, according to all 27 economists surveyed by Bloomberg News.

This would be the sixth rate increase since Howard, 68, won the 2004 election with a promise to keep interest rates at ``record lows,'' and may negate his claim that he is a better economic manager than opposition Labor Party leader Kevin Rudd, 50, who is leading opinion polls. Stevens, 49, wants to stem inflation, already at the top of his target range.

``The bank's board has no option but to increase rates; the economy is at full stretch,'' Bernie Fraser, central bank governor for seven years until 1996, said in an interview from Canberra. ``Stevens and his board will not be deterred by the election,'' added Fraser, who introduced inflation targeting in 1993.

Speculation of a rate increase intensified after an Oct. 24 report showed core consumer prices jumped by the most in 16 years in the third quarter. That pushed annual inflation to 3.1 percent, breaching the 3 percent limit of the central bank's target band.

Investors see a 90 percent chance of a rate increase this week, according to a Credit Suisse Group index based on trading in interest-rate swaps. That probability was 58 percent before the inflation report.

Governor's Stance

Stevens, who was appointed governor in September 2006, said in August he was prepared to adjust rates during an election campaign. He and his board last raised the benchmark to an 11-year high of 6.5 percent on Aug. 8.

``If it's clear that something needs to be done, I do not know what explanation we could offer the Australian public for not doing it, regardless of when the election might be,'' Stevens told parliament on Aug. 17.

Another rate move will be unpopular among voters with mortgages, adding A$42 ($39) a month to repayments on an average home loan. Households are carrying record debt of 161 percent of disposable income.

The A$1 trillion economy is in its 16th year of expansion, spurred by demand for commodities from China and India. Australia is the biggest shipper of coal, iron ore and wool. The jobless rate is at a 33-year-low of 4.2 percent.

`Difficult Position'

``The economy, driven by a once-in-a-lifetime mining boom, puts Stevens in a difficult position,'' David Moore, managing director of Perth-based Mincor Resources NL, said in an interview. ``He has no option but to increase rates; Howard is not his master.''

Australia's central bank is relatively late in being effectively independent. Its inflation-targeting mandate was only enshrined when Howard's Treasurer, Peter Costello, signed an agreement with then governor-designate Ian Macfarlane in 1996.

Stevens and his board meet tomorrow and release their decision the following day at 9:30 a.m. in Sydney.

Treasury Secretary Ken Henry, Australia's top financial bureaucrat, is one of nine board members, who include business executives and academics appointed by the government.

``We've achieved central bank independence with great difficulty in Australia, so why risk that with a rate increase that isn't necessary,'' said Michael Knox, an analyst at ABN Amro Morgans Ltd. in Brisbane. ``The slowing U.S. economy will temper Australian growth, providing the RBA with reason to stand aside.

`Incense a Generation'

``A rate increase in an election campaign, which led to the fall of the government, would incense a generation of coalition voters,'' said Knox.

Even as inflation accelerates, the Australian economy, which expanded 4.3 percent in the second quarter from a year earlier, is being buffeted by the worst drought on record and slowing global growth sparked by the U.S. housing recession.

The Federal Reserve cut its key rate to 4.5 percent last week, the second reduction in as many months. The Bank of Japan left its rate at 0.5 percent on Oct. 31.

Australia's exports, which make up 20 percent of the economy, fell 4 percent in September.

Currency Rally

Farmers and miners are also suffering with a currency at its strongest for more than two decades, which reduces export earnings.

The Australian dollar has gained 17 percent this year against the U.S. currency. A rate increase will widen the gap with U.S. borrowing costs, making higher-yielding Australian investments more attractive.

``Global prices are very good, so it's a pity farmers can't take advantage of it because of the drought and the high Australian dollar,'' Donald McGauchie, a central bank board member and farmer, said in an interview from Melbourne.

Rudd holds an eight-point lead in voter support over Howard, which would have delivered Labor victory if an election were held two weekends ago, according to the latest Newspoll published on Oct. 30. The poll had a margin of error of plus or minus 3 percentage points. Howard's approval rating in recent polls has been at the lowest since he won power.