RBA hikes but remains cautious in their rate outlook

The Reserve Bank of Australia has met expectations with a 25 basis point increase to the cash rate announced at their meeting on Melbourne Cup Day. The move follows a hike last month as the central bank moves toward a more “normal” setting of monetary policy*.

Amid the euphoria in the lead up to the Cup, the RBA Board decided to raise the cash rate by 25 basis points to 3.5 per cent, effective 4 November 2009. The central bank said the move was “prudent” given the relative strength of the economy, however future movements remain up in the air.

The cash rate still remains well below the 7.25% mark reached prior to the onset of the global financial crisis.

The 25 basis point rise had been expected by the market, although there were a few brave souls willing to bet on a 50 basis point hike based on recent commentary from RBA Governor Glenn Stevens - who said the bank must be careful not to be too “timid” in their rate movements on the way up. Taken out of context, his words scared many market watchers, but realistically little had changed in the central bank’s rhetoric. And, yesterday, Mr Stevens was far more circumspect in his discussion about the rate movement.

“With the risk of serious economic contraction in Australia now having passed, the Board’s view is that it is prudent to lessen gradually the degree of monetary stimulus that was put in place when the outlook appeared to be much weaker,” he advised.

“The adjustments at the October and November meetings will work to increase the sustainability of growth in economic activity and keep inflation consistent with the target over the years ahead.”

His assertion that the central bank will lessen monetary policy stimulus “gradually” was warmly received by most, although the rate hikes will continue over the coming year - provided the Australian economy continues to show signs of improvement. Credit markets are now hedging their bets as to whether the next rise will come in December or the first quarter of next year.

Prior to yesterday’s announcement most had been forecasting a rise in December to follow the October and November rises, but now the majority are expecting the RBA to hold off until February. However, economic data over coming weeks will be the deciding factor.

Treasurer Wayne Swan said the move, which will add around $45 per month to the average monthly mortgage repayment, was not welcome but necessary.

“Today’s decision is a tough one for many Australian families and businesses, but rates could not stay at 50-year emergency lows forever,” he told reporters. “Because the economy is recovering, we will see changes in rates from time to time.”

* The “normal” setting that Mr Stevens alludes to is likely to be somewhere in the range of five to six per cent. However, analysts do not anticipate the central bank reaching the lower end of that range until beyond 2011.

Posted Thursday 5th of November 2009, 4:26 PM