Australia Central Bank Shift Makes Rate Rise Likely

By Jacob Greber

Aug. 5 (Bloomberg) -- Australia’s central bank signaled that its next move in interest rates may be an increase as the economy gathers momentum, spurred by gains in housing and government spending.

The Reserve Bank of Australia kept its benchmark rate at 3 percent yesterday, and Governor Glenn Stevens in an accompanying statement dropped language used in the past two months to having “some scope for further easing of monetary policy.” The economy is “stronger than expected a few months ago,” he said.

Stevens’s shift reflects concern that the RBA’s record 4.25 percentage points of rate cuts, if left in place too long, may inflate a housing bubble, destabilizing the economy. The change also follows an acceleration in growth in China, Australia’s second-biggest export market, that’s spurring forecasts for higher prices of commodities, the nation’s main exports.

“The next step will be for the Reserve Bank to begin to withdraw at least some of this accommodative setting,” starting in December with a quarter-point increase, predicted Paul Brennan, an economist at Citigroup Inc. in Sydney.

Investors predict Australia’s benchmark overnight cash rate target will be 154 basis points higher in a year, a Credit Suisse Group AG index showed at 2:43 p.m. in Sydney.

Currency Gains

Speculation Stevens, 51, will begin raising rates as soon as this year also helped push the nation’s currency to a 10- month high of 84.71 U.S. cents. It traded at 84.27 at 2:52 p.m. in Sydney today.

Reports yesterday showed retail sales jumped last quarter by the most in almost two years and house prices surged. Stevens warned last week about the risks of a house-price bubble with borrowing costs at a 49-year low.

Rising Australian consumer and business confidence “suggests the risk of a severe contraction in the Australian economy has abated,” Stevens said yesterday. “The present accommodative setting of monetary policy is appropriate given the economy’s circumstances.”

While some analysts predict Stevens will begin raising borrowing costs as soon as this year, others including Craig James, a senior economist at Commonwealth Bank of Australia, argue policy makers are “certainly not suggesting that rate hikes are imminent.”

“The Reserve Bank will want to ensure the economy can stand on its own two feet -- without being propped up by the government -- before deciding to lift rates,” James said.

Rudd’s Stimulus

Prime Minister Kevin Rudd’s government has distributed A$12 billion ($10.1 billion) in cash handouts to households this year and is spending A$22 billion to upgrade roads, railways, ports and schools.

An index measuring the weighted average of prices for established houses in the eight capital cities climbed 4.2 percent from the first quarter, more than double the median gain forecast in a Bloomberg survey.

Stevens said last week that it will be “quite disturbing” if the cuts to borrowing costs result in higher prices and not many more new dwellings.

Other signs the economy is strengthening include reports today and yesterday showing exports rose in June and retail sales jumped 2 percent in the second quarter from the previous three months. Macquarie Group Ltd. economist Ben Dinte estimates retail sales account for as much as 25 percent of gross domestic product.

Household spending helped Australia’s economy avoid a recession after GDP rose 0.4 percent in the first quarter from the previous three months, when it shrank 0.6 percent. Second- quarter growth figures will be released on Sept. 2.

2010 Outlook

While household spending is “likely to slow somewhat,” stronger dwelling activity and government spending “will start to provide more support to overall demand soon, and is likely to firm into 2010,” Stevens said yesterday.

The central bank, which predicted in May that GDP would contract 1 percent this year before expanding 2 percent in 2010, will publish revised forecasts on Aug. 7.

Nouriel Roubini, the New York University economist who predicted the global financial crisis, told a mining conference in Western Australia on Aug. 3 that Australia’s central bank may be one of the first to increase borrowing costs after the global economic downturn.

“Hopefully” policy makers will find “a suitably timely way of returning to normal when the right time for that comes,” Stevens said on July 28.

To contact the reporter for this story: Jacob Greber in Sydney at jgreber@bloomberg.net