Expansionary shock forces RBA's hand on rates

Reserve Bank increases interest rates amid warnings of rising inflation due to an "expansionary shock" in trade

By Brad Gardner | November 2, 2010

The Reserve Bank has lifted interest rates to 4.75 percent in an early strike to counter inflationary growth in the Australian economy.

As punters focused their attention on the Melbourne Cup today, the RBA board decided to lift rates by 25 basis points from tomorrow.

While saying inflation is running about 2.5 percent – within the RBA’s band –Governor Glenn Stevens adds that the economy is undergoing "a large expansionary shock" from the highest terms of trade since the early 1950s.

"Looking ahead, notwithstanding recent good results on inflation, the risk of inflation rising again over the medium term remains."

"At today’s meeting, the Board concluded that the balance of risks had shifted to the point where an early, modest tightening of monetary policy was prudent."

As business investment and the labour market improves, Stevens says the moderation in inflation over the past two years is "probably now close to ending".

"Inflation is likely to rise over the next few years. This outlook, which is largely unchanged from the Bank’s earlier forecasts, assumes some tightening in monetary policy."

The high Australia dollar, which briefly reached parity with the US last month, is expected to help contain inflation.

Stevens says the global economy will slow over the coming year after growing faster than trend pace to mid 2010.

He says US and European economies are still experiencing slow growth, but predictions of a larger than expected slowing Chinese economy are unlikely.

"The turmoil in financial markets earlier in the year has abated, though sentiment remains fragile," Stevens says.

Despite signs of a greater willingness to lend by the banks, Stevens says credit growth is subdued.

It’s a different story for wages, with Stevens saying there has been an expected growth after a significant decline in 2009.

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