Australian Rate Increase Looms as Economy Accelerates

By Jacob Greber

Sept. 3 (Bloomberg) -- Pressure is mounting on central bank Governor Glenn Stevens to raise interest rates from a half- century low as soon as next month after a report yesterday showed the economy strengthened on surging consumer spending.

Investors have a more than 100 percent expectation Stevens will boost borrowing costs in November by a quarter point to 3.25 percent, according to interbank futures on the Sydney Futures Exchange at 10:49 a.m. There is also a 28 percent probability of a move on Oct. 6, the futures show.

Australia’s economy unexpectedly accelerated in the second quarter at the fastest pace in more than a year as A$20 billion ($16.7 billion) of government cash handouts boosted spending at retailers such as Harvey Norman Holdings Ltd. Stevens may become one of the first policy makers in a developed economy to begin raising borrowing costs since the collapse of Lehman Brothers Holdings Inc. almost a year ago.

“A 3 percent cash rate is inconsistent with an economy growing this fast,” said Matthew Johnson, interest-rate strategist at UBS AG in Sydney. “If the central bank were meeting now, they would raise rates.”

“There’s too much momentum going into the second half of the year, which makes it unlikely the economy will slow,” he added. “Inflation pressures are only going to intensify.”

Gross domestic product rose 0.6 percent in the second quarter from the previous three months when it grew 0.4 percent, three times faster than the 0.2 percent median estimate of 20 economists surveyed by Bloomberg News.

Interest-Rate Swaps

Traders forecast the central bank’s overnight cash rate target will be 172 basis points higher in 12 months, according to a Credit Suisse Group AG index based on interest-rate swaps at 12:57 p.m. in Sydney. Prior to yesterday’s GDP report, they tipped 171 basis points of gains.

By contrast, the U.S. Federal Reserve is tipped to raise borrowing costs by 72 basis points in the next year and the European Central Bank by 53 basis points.

“Something bad now needs to happen to stop the Reserve Bank from fast-tracking its first hike to October,” said Rory Robertson, an economist at Macquarie Group Ltd. in Sydney. “The Australian economy grew 1 percent in the first half of the year, confounding many forecasts it would shrink.”

The Reserve Bank scrapped its forecast last month for the economy to contract this year, instead predicting gross domestic product will expand 0.5 percent. The bank expects growth will accelerate to 2.25 percent in 2010 and 3.75 percent in 2011.

Annual Growth

Yesterday’s report suggests the bank will be forced to raise its growth forecasts again when it next publishes its quarterly predictions in November, UBS’s Johnson said.

The economy grew 0.6 percent from a year earlier, twice the pace forecast by economists, the Bureau of Statistics reported yesterday in Sydney.

Analysts had cut their growth forecast on Aug. 31 and Sept. 1 after reports showed a widening current account deficit in the second quarter and a record drop in business inventories.

Consumer spending jumped 0.8 percent in the second quarter, the largest gain since the three months through December 2007, adding 0.5 percentage point to GDP, the bureau said.

Australia’s trade deficit widened in July as imports surged 4 percent, the most in almost a year, a report showed today.

Government spending, which also jumped 0.8 percent in the second quarter and contributed 0.1 percentage point to growth, may accelerate in coming months as Prime Minister Kevin Rudd spends A$22 billion on roads, railways, ports and schools.

‘Stronger Than Expected’

Stimulus from governments also helped lift Germany out of its worst recession since World War II, a report showed on Aug. 25. Europe’s largest economy grew 0.3 percent from the first quarter following four quarters of contraction. France’s economy, the second-biggest in the euro region, unexpectedly exited a yearlong recession, gaining by the same amount as Germany.

By contrast, the U.K.’s economy shrank 5.5 percent in the second quarter, the most since records began in 1955, and U.S. GDP dropped 1 percent.

Australia’s economy has been “stronger than expected,” Governor Stevens said on Sept. 1 when he kept the overnight cash rate target at a 49-year low of 3 percent for a fifth month.

“The likelihood of inflation being persistently below” the bank’s target range of between 2 percent and 3 percent “now looks low,” Stevens said.

Retail Sales

Still, there are some signs economic growth may cool in the third quarter. Retail sales fell in June for the first time in four months, exports and inventories slumped in the second quarter and bank lending to businesses shrank for a sixth month in July.

“Prime Minister Kevin Rudd’s fingerprints” are all over the first-half rise in GDP, said Annette Beacher, a senior economist at TD Securities Ltd. in Singapore. “The bigger test going forward is how the economy copes without the cash handouts and generous fiscal incentives.”

Before central bank policy makers meet again in five weeks, figures will be published on home loans, retail sales, unemployment and consumer sentiment.

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