WRAPUP 1-Australia inflation eyed after c.bank flags rate hikes

Published: 14 Oct 2009 21:53:40 PST

* RBA chief: rates to be adjusted as recovery picks up

* Stevens says goal during expansion is to keep inflation low

* Remarks fuel talk of bigger than expected 50 bps Nov hike

* Markets await Q3 inflation data on Oct. 28 for more cues

SYDNEY, Oct 15 - Australia's top central banker said on Thursday interest rates needed to rise and signalled he was keeping a closer eye on prices, stirring speculation a jump in inflation could trigger a 50 basis-point hike next month. The comments spurred the Australian dollar to 14-month highs as investors priced in the chances of more aggressive rate rises as the economy recovers. Markets had earlier expected the central bank to raise rates by 25 basis points at its November meeting.

Neighbouring New Zealand on Thursday reported stronger-than expected quarterly inflation, stoking talk that Australia may also report growing price pressures when it releases third-quarter consumer price data on Oct 28. [ID:nSYD485255]

Reserve Bank of Australia Governor Glenn Stevens said in a speech that the risk of serious economic weakness had abated and that he would not be timid in removing some of the monetary policy stimulus put in place to help the economy ward off the worst of the global financial crisis.

The comments were his first in public since the central bank's surprise decision last week to raise the cash rate by a quarter of a percentage point.

As the economy expands, the RBA's objectives would be to keep inflation low, Stevens added, noting price pressures have been unexpectedly stubborn despite the recent downturn.

"We have said that, over time, interest rates will need to be adjusted towards a more normal setting as the economy recovers," Stevens said, without giving a specific number or range.

"In conducting monetary policy during this expansion, our objectives will be ... to keep inflation low; to react in a measured but prompt fashion to changes in the risks facing the economy; and, in so doing, to play our part in fostering a long, sustainable period of growth."

The RBA aims to keep headline inflation in a 2-3 percent band, but the second quarter-core inflation rate was 3.9 percent higher than a year ago.

"In fact, in late 2009, we are still to see whether inflation will be consistently back to target over a period of time," Stevens said.

Michael Blythe, chief economist at Commonwealth Bank, said this comment was an implicit suggestion that upside inflation risks are building again.

"We expect a 25 basis point rise in November with a 50 basis point move contingent on a 'high' third-quarter consumer price index number," Blythe said.

Last week, the RBA became the first in the Group of 20 to raise interest rates since the global downturn began to ebb, bringing its key rate to 3.25 percent and highlighting the outperformance of the local economy. The RBA also heralded more hikes ahead, leading the market to fully price in another 25 basis point hike for November <CSRBA=CSAU>.

But after Stevens' latest comments, investors were factoring in a nearly 40 percent chance of an unusually hefty 50 basis point hike to 3.75 percent when the RBA's monetary policy board next meets on Nov. 3.

"The governor's language was more aggressive than we were expecting," said Spiros Papadopoulos, economist at National Australia Bank. "His comments suggest that the cash rate may move higher and faster over coming months than currently expected."

The Australian dollar <AUD=D4> rose after the governor's comments to $0.9223 from $0.9160 while swap rates jumped as investors priced in more chances of rate hikes in coming months.

Interbank futures <0#YIB:> were 0.09 points down to imply a one-month rate of 3.83 percent in December, and one-year overnight indexed swaps <AUDOIS> jumped to 4.5275 percent from 4.395 percent. That was the highest level since Oct. 31.

ECONOMY HOLDING UP WELL

Stevens has declined to say what a "normal" rate setting is, but former RBA Governor Ian Macfarlane has nominated a range of 5.25-6.25 percent. Rory Robertson, interest rate strategist at Macquarie, sees normal rates at around 5 percent.

Financial markets <CSRBA1Y=CSAU> are already pricing rates at 5.25 percent after 12 months as economic data continues to surprise on the upside and the job market holds up pretty well.

"If the downtrend in full-time employment continues to stabilise and then reverse, we can expect the RBA over an extended period to move through its various policy settings, from emergency towards 'easy' which is 4 percent and then 'neutral'," Robertson said.

Australia is one of the few developed countries to dodge a recession, with its housing and banking sectors holding up well compared with a battering in those areas in the West.

In addition, its largest export markets are in Asia, dominated by China and South Korea, economies which have weathered the global downturn in reasonably good shape.

"None of this is to say that the economy is, at this moment, 'too strong'. It isn't," Stevens said.

"The point is, rather, that the very low interest rate settings were designed for a weaker economy than we are in fact facing. Plainly, the downside risks to which the board was responding earlier have not materialised."

Australian employment surged past all expectations in September while the jobless rate dropped to 5.7 percent from 5.8 percent, data showed last week.

Stevens said the period of greatest weakness in the Australian economy was probably past and, barring another serious international setback, the economy was likely to continue on a path of gradual expansion during 2010. (Additional reporting by Fayen Wong in PERTH)