RBA Signals Further Rate Increases, Tolerance of Currency Gains

By Jacob Greber

Oct. 20 (Bloomberg) -- Australia’s central bank signaled it’s prepared to keep raising interest rates and tolerate further appreciation in the nation’s currency to help restrain consumer prices as the economy strengthens.

A “very expansionary setting of policy was no longer necessary, and possibly imprudent,” officials said in minutes of an Oct. 6 meeting, released today in Sydney. Gains in the nation’s dollar, the best-performing this month of the 16 most- traded currencies, “may help contain inflation,” they said.

The minutes drove Australia’s currency above 93 U.S. cents, the highest level in 14 months, as investors bet Reserve Bank Governor Glenn Stevens will boost the overnight cash rate target next month. Stevens unexpectedly raised the benchmark a quarter point to 3.25 percent this month, becoming the first Group of 20 central banker to increase borrowing costs.

“The dollar is well and truly on the way to parity” versus the U.S. currency, said Savanth Sebastian, an economist at Commonwealth Bank of Australia in Sydney. “At this early stage, the Reserve Bank isn’t worried about the currency because their concern is to remove stimulus. Once they get back to a neutral setting and the currency is at parity, they’ll start to look at holding interest rates steady.”

The Australian dollar jumped to 93.11 U.S. cents immediately after the minutes were released from 92.76 cents earlier. It traded at 92.86 cents at 5:12 p.m. in Sydney.

Inflation Threat

Holding rates at their current “very low levels” could threaten the bank’s target of keeping inflation between 2 percent and 3 percent, the Reserve Bank said in the minutes.

Annual core inflation, which excludes food and energy costs, was 4.2 percent in the three months through June, a report showed on July 22. Third-quarter figures will be published on Oct. 28.

Barclays Capital, Citigroup Inc. and National Australia Bank have forecast the Australian dollar will reach parity in six to 12 months.

Investors are certain Stevens will raise the benchmark rate by at least another quarter point on Nov. 3, according to Bloomberg calculations based on interbank futures on the Sydney Futures Exchange. Chances of a half-point increase next month were 20 percent, the futures showed at 4:28 p.m., down from 26 percent prior to the minutes.

Government Stimulus

Policy makers noted that there was still a possibility the economy’s recent strength was due to the impact of A$42 billion ($39 billion) in government spending and handouts, which “left open the attendant risk that activity might slow as that stimulus faded.”

“It was also likely that the appreciation of the exchange rate would act as a contractionary influence on activity and help contain inflation,” the minutes said.

Philip Lowe, assistant governor at the Reserve Bank, said in Sydney this week the nation’s currency has gained because Australia has “a high return of capital with a lot of investment.”

“We will have a higher average exchange rate than we’ve had over the past couple of decades,” Lowe said on Oct. 19.

Australia’s currency has averaged 72 U.S. cents since being floated in December 1983, according to data compiled by Bloomberg. It has surged 54 percent since hitting a five-year low on Oct. 27 last year.

Stevens said last week that experience “counsels against” an approach where policy makers who cut rates rapidly in response to a threat become “too timid to lessen that stimulus in a timely way when the threat has passed.”

Woolworths Chief

“It would go against history to think the low rates we have at the moment will continue ad infinitum,” Michael Luscombe, chief executive officer of Woolworths Ltd., Australia’s largest retailer, said in an interview.

The benchmark rate will rise above 5 percent if policy makers “determine the economy is overheating or inflation is getting out of control,” Luscombe added.

Australia’s economy “had for some time been noticeably stronger than had earlier been expected,” today’s minutes said.

Gross domestic product rose 1 percent in the first half of this year as consumers increased spending, spurred by the central bank slashing borrowing costs by a record 4.25 percentage points between September last year and April.

Policy makers noted that a “sizeable gap” had opened up between the performance of Australia and other developed economies. “The board had to be mindful of local conditions in setting policy,” the minutes said.

Such commentary was “extremely bullish on rate hikes and there wasn’t too much discussion about currency concerns,” said Commonwealth Bank’s Sebastian. “In years gone by, you would have seen discussion about the impact of the Australian dollar and how it’ll curtail growth.”

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