The Reserve Bank of Australia has shocked the market by raising official interest rates by 0.25% to 4.75% this afternoon, citing a looming risk of rising inflation.
The decision is an unexpected one. Economists had tipped rates to remain steady in light of the recent official inflation data, which was lower than expected.
In a statement, RBA governor Glenn Stevens said the economy has grown faster than trend over the year to mid 2010, and that global growth will “probably” ease back to about trend pace over the coming year.
“At the same time, concerns about the possibility of a larger than expected slowing in Chinese growth have lessened recently and most commodity prices have firmed, after a fall earlier in the year.”
“The prices most important to Australia remain at very high levels, with the result that the terms of trade are at their highest since the early 1950s. The turmoil in financial markets earlier in the year has abated, though sentiment remains fragile.”
Stevens also noted that asset values are not moving in either direction, credit growth remains quite subdued and the exchange rate has risen “significantly”, reflecting the high level of commodity prices.
Along with firm demand for labour and wages growth, Stevens said the moderation in inflation that has been underway for two years is now close to ending.
“Recent information suggests underlying inflation running at about 2.5 %, with the CPI inflation rate a little higher due mainly to increases in tobacco taxes.”
“Both results were helped somewhat in the latest quarter by unusual softness in food prices. Inflation is likely to rise over the next few years. This outlook, which is largely unchanged from the Bank’s earlier forecasts, assumes some tightening in monetary policy.”
As a result, Stevens says a move in interest rates is necessary due to the “large expansionary” shock from high terms of trade and “relatively modest amounts of space capacity”.
“Looking ahead, notwithstanding recent good results on inflation, the risk of inflation rising again over the medium term remains. At today’s meeting, the Board concluded that the balance of risks had shifted to the point where an early, modest tightening of monetary policy was prudent.”
The article first appeared on Smart Company