Low interest rates era over in Australia

The markets had priced a 25 basis point rise at short odds on Melbourne Cup day. Photo / Getty Images

The Reserve Bank of Australia raised interest rates as expected yesterday, but the bank's fight with inflation in the future will see further tightening of monetary policy, economists say.

The bank lifted the overnight cash rate by 25 basis points to 3.50 per cent.

Financial markets had priced a 25 basis point rise at short odds on Melbourne Cup day.

The rise made a quadrella of November rate movements by the central bank after 25 basis point increases in 2006 and 2007 followed by a 75 basis point cut last year.

RBA governor Glenn Stevens said the era of low interest rates had passed as the local economy continued to improve.

"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," Stevens said.

"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."

RBC Capital Markets senior economist Su-Lin Ong said the board noted that a stronger Australian dollar could help in its fight with inflation.

"What's new in the statement in this discussion about the exchange rate is that it may constrain output and dampen price pressures," Ong said.

"It is a roundabout way that the RBA is saying that the currency is doing a bit of the work for them.

"I don't think it will do enough of their work and they will continue to lift rates."

Ong forecast the central bank would lift by 25 basis points to 3.75 per cent at its next board meeting on December 1.

"As they say, despite the exchange rate, growth will be near-trend in the year ahead and inflation will be near target," she said.

"That does not give them much wriggle room."

Borrowers with an average standard variable mortgage of A$300,000 ($374,000) will pay an extra A$48 a month if the commercial banks pass on the rate rise.

National Australia Bank economist David de Garis seized on Mr Steven's comments that the board felt it prudent to "lessen gradually the degree of monetary stimulus that was put in place when the outlook appeared to be much weaker".

"That says to me they're going to continue on 25 basis point rises," de Garis said.

He forecast the RBA would continue raising rates by 25 basis points at every board meeting until it reached a rate of 4.25 in March.

Steven's statement of monetary policy was "fairly balanced," he said.

"It's not all upside risk on the economy. It also mentioned the exchange rate, despite the fact they've made some upward revisions to growth and inflation.

"So it's got some sort of dovish tinge to it."

The RBA had not given the impression that once it had removed the emergency rate cuts it would raise rates by more than 0.5 per cent, he said.

"I think the policy is going to remain at an expansionary level, just not at the super expansionary level we had until two months ago.

"There's nothing in here that suggests they're going to ramp up from 25 to 50 [basis points] at the next meeting."

CommSec economist Craig James said the 25 basis point rate rise - the bank's second rate hike in a row - was a responsible move that did not threaten Australia's economic growth.

But he said there was little that pointed to the pace of future rate rises.

"It's clear that the Reserve Bank didn't want to frighten the horses with its latest rate hike," Mr James said.

"Very sensible that they're gradually lessening stimulus in the system but by no means threatening the recovery in place.

"Perhaps when it comes to the New Year, when things become a little bit clearer about the global economy, they might lift by more than 25 basis points."

Some market observers forecast a 50 basis point rise this month.

But those predictions faded following the publication of the official inflation indictor, Consumer Price Index (CPI), that showed headline inflation at its lowest point in a decade.

Mr Stevens also noted that the rising Australian dollar would further dampen inflation and put downward pressure on the export sector.

"The exchange rate has appreciated considerably over the past year, which will dampen pressure on prices and constrain growth in the tradeables sector," Mr Stevens said.

The local unit has gained roughly US33c since it's global financial crisis low of US60.12c on October 29 last year.

It has hovered around US90c for the past week.

"It was interesting that the RBA has taken note of the exchange rate," Mr James said. "It's highlighting that there are risks in lifting rates too far, too fast.

Head of research at financial markets research group 4Cast, Ray Attrill, said the RBA hinted that the central bank may choose to leave the cash rate unchanged next month.

Mr Attrill said it was "curious" the RBA would choose to reference both the October and November meeting.

"We see no reason why they should pause any time soon, but by referencing October and November it does raise the possibility that they are offering a signal that they are going to now pause and wait until February," Mr Attrill said. "I would read it to say that they are raising the possibility that they think they will pause in December."

- AAP