Rba's Rate Riddle A Dream Turn For Currency

Sydney Morning Herald

Wednesday February 20, 2008

Vanessa Burrow

CURRENCY markets reacted exuberantly to news the Reserve Bank recently considered raising interest rates by half a percentage point, taking the Australian dollar to within two US cents of a 23-year high.

The dollar reached US92.08c yesterday - its highest in more than three months - after minutes from the RBA's February meeting showed the board had a hard time deciding whether to raise interest rates by 25 or 50 basis points.

Market interest rates also climbed and the Australian bond market ended weaker as the minutes boosted speculation rates would rise next month and again in May. The debt futures market is now tipping a 90 per cent chance of a rate rise next month.

The RBA has moved in increments of 25 basis points since April 2001, when it cut official interest rates from 5.5 per cent to 5 per cent in one hit. It hasn't raised the official cash rate by 50 basis points since February 2000.

A JPMorgan economist, Helen Kevans, said the key to convincing the RBA to stick with recent tradition was increases in borrowing rates by financial institutions outside an official rise.

"Members noted that an argument in favour of a rise of only 25 basis points was that the level of rates faced by borrowers had already risen somewhat over the summer, independently of policy action," the minutes say. "A rise of 25 basis points now would produce a total rise over nine months of about 100 basis points (or one percentage point) for business borrowers and 90 basis points for housing borrowers."

Credit Suisse said market betting on a March 4 rate rise - from 7 per cent to at least 7.25 per cent - had risen to 92 per cent from 84 per cent.

Most economists predict a further rate increase in May after the release of first-quarter consumer price index figures, which are expected to show inflation is on the rise.

Michael Workman, a senior economist at Commonwealth Bank, predicts rates will rise 50 basis points by May.

Comments made yesterday by the RBA's assistant governor (economic), Malcolm Edey, consolidated those expectations by emphasising the strength of Australia's trading partners despite a "generalised slowdown in the major industrial countries".

Australia will benefit from an increase of more than 65 per cent in the contract price for iron ore this week and from a spike in coal prices.

"Australia's iron ore exports are currently $15.5 billion and together with coal make up around 17 per cent of total exports of goods and services, so price rises such as these will measurably lift Australia's terms of trade in the year ahead," David de Garis, a senior market economist at nabCapital Research, said in a report.

Mr Edey said the RBA expected Australia's terms of trade to "rise by another 5 per cent or so this year, but to fall gradually thereafter".

To read the RBA's February minutes and RBA assistant governor Malcolm Edey's comments go to www.rba.gov.au.

© 2008 Sydney Morning Herald

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