Australia Will Raise Key Rate to at Least 3.5% (Update2)

By Jacob Greber


Nov. 3 (Bloomberg) -- Australia’s central bank will raise its benchmark interest rate today by at least a quarter percentage point, the second increase in four weeks, amid signs the economy is strengthening, economists and traders say.

Reserve Bank Governor Glenn Stevens will boost the overnight cash rate target to 3.5 percent from 3.25 percent at 2:30 p.m. in Sydney, according to 18 of 22 economists surveyed by Bloomberg News. The rest expect a half-point increase. Futures traders are betting on a quarter-point boost.

Keeping borrowing costs at “very low levels” may be “imprudent” and threaten its inflation target, the bank said last month, amid surging consumer confidence, house price gains and Chinese demand for natural resources. Stevens, the first Group of 20 policy maker to raise borrowing costs since the height of the global recession, has also signaled this year’s 29 percent gain in the nation’s currency may help contain inflation.

“The case for a larger-than-expected increase is always strongest at the early stages of the tightening cycle,” said Bill Evans, chief economist at Westpac Banking Corp. in Sydney, who predicts a half-point gain. “The risks of tightening too slowly are also high when policy is at its most stimulatory since imbalances are more likely to emerge.”

The Australian dollar rose for a second day to 90.80 U.S. cents as of 1:13 p.m. in Sydney from 90.40 in New York yesterday.

Australia’s economy is growing faster and generating more jobs than Treasurer Wayne Swan forecast six months ago, helped by A$20 billion ($18 billion) in government cash handouts to consumers and Stevens’ record interest-rate cuts between September 2008 and April, when he slashed the benchmark rate by 4.25 percentage points to a half-century low of 3 percent.

Economic Growth

Stevens raised the rate by a quarter point Oct. 6. The only other countries to raise borrowing costs this year are Israel and Norway.

Gross domestic product will expand 1.5 percent in the 12 months to June 30, 2010, Treasurer Wayne Swan said yesterday after scrapping his May prediction of a 0.5 percent contraction. GDP will accelerate to 2.75 percent the following fiscal year, he said. The economy grew 1 percent in the first six months of this year.

Unemployment is also expected to peak at 6.75 percent in the second quarter of next year, well below the 8.5 percent rate Swan forecast in May for the three months through June 30, 2011.

“The Australian economy has turned out to be quite a lot stronger than we thought,” Reserve Bank Assistant Governor Philip Lowe said last month. “It’s entirely appropriate we go back to a more normal setting in monetary policy. And that’s the process that’s under way.”

House Prices

There are also signs of a surge in some asset prices. A report published yesterday showed Australian house prices jumped 4.2 percent in the three months through September from the previous quarter, when they rose by the same amount. The nation’s benchmark S&P/ASX 200 index of stocks has climbed more than 20 percent this year.

Stevens should raise borrowing costs today to keep a lid on an “irrational exuberance” in the housing market that is “arguably now out of line,” Mark Joiner, National Australia Bank Ltd.’s chief financial officer, told the Australian Financial Review in an interview published on Oct. 31.

Still, Stevens has scope to limit today’s increase to a quarter-point move, which would add A$50 to monthly repayments on an average A$300,000 home loan.

Reports published in recent days show bank lending unexpectedly fell in September for the first time in nine months amid weaker demand for business credit, and manufacturing growth slowed in October.

Inflation Slows

The consumer price index rose in the third quarter by an annual 1.3 percent, the smallest gain since the second quarter of 1999, after advancing 1.5 percent in the previous three months, a government report showed on Oct. 28.

Inflation isn’t “sufficiently high to justify the Reserve Bank accelerating to a half-point hike,” said David de Garis, a senior economist at National Australia Bank Ltd. in Sydney.

Investors are certain Stevens will raise the overnight cash rate target by a quarter point, according to Bloomberg calculations based on interbank futures on the Sydney Futures Exchange. They expect only an 8 percent chance of a half-point increase, the index showed at 8:33 a.m.

The Reserve Bank, which scrapped its forecast in August for the economy to contract this year, will publish revised predictions on Nov. 6. Its most recent estimate was for GDP to expand 2.25 percent in 2010 and 3.75 percent in 2011.

“The Reserve Bank’s rate hikes will come regularly -- at every meeting until February -- but in small steps,” said Stephen Walters, chief economist at JPMorgan Chase & Co. in Sydney. “There is little to be gained from spooking the horses” today with a half-point gain.