RBA Raised Cash Rate to 4%, Resuming the Tightening Cycle

After pausing in February, the RBA resumed its tightening cycle in March by announcing to raise its cash rate by +25 bps to 4%. In the accompanying statement, the central bank stated that interest rates to most borrowers 'remain lower than average' and 'growth is likely to be close to trend and inflation close to target over the coming year, it is appropriate for interest rates to be closer to average'.

This is the first time in 3 months that the RBA decided to increase the policy rate. Economic developments since the previous meeting have been robust. The number of payrolls rose +52.7K in January, following an increase of +37.5K in the prior month. Unemployment rate, which should have peaked at 5.8% in July 2009, fell for the 3rd consecutive month to 5.3% in January. Released earlier today, retail sales jumped +1.2% m/m in January, compared with consensus of +0.8% and -0.9% in December. Growth in consumer spending is a sign of rising confidence and suggests that inflationary pressure may increase.

In the accompanying statement, the RBA said that 'labor market data and a range of business surveys suggest growth in the economy may have already been at or close to trend for a few months'. 'The process of business sector de-leveraging is moderating, with the pace of decline in business credit lessening and indications that lenders are starting to become more willing to lend to some borrowers'. At the same time, 'credit for housing has been expanding at a solid pace, and dwelling prices have risen significantly over the past year'. Concerning inflation, the central bank anticipates it to be 'consistent with the target in 2010'.

AUD surged after the announcement but selling pressures emerged shortly. We believe the rate hike is positive for AUD as it widened the interest rate differential between Australia and the US.

RBA Governor Glen Stevens stated that 'interest rates to most borrowers nonetheless remain lower than average... it is appropriate for interest rates to be closer to average. Today's decision is a further step in that process'. This signaled the tightening cycle remains in progress and further rate hikes are coming. We expect RBA's cash rate will reach 4.75% by end-2010.