RBA Leaves Key Interest Rate Unchanged At 6.5%

Sep 5, 2007 - In a widely anticipated move, the Reserve Bank of Australia announced on Wednesday that it is maintaining its benchmark interest rate at 6.50%. At its August meeting, the central bank had increased its key overnight cash rate target by 25 basis points to an eleven-year high of 6.50%.

Some analysts speculate another rate hike before the year- end amid expectations that strong economic growth will fuel inflationary pressure. Australia's economy expanded a faster-than-expected 0.9% in the second quarter on a sequential basis, and logged a solid 4.3% year-over-year growth.

The growth was driven by a surge in business investment, which climbed 4.5% and contributed 0.7 percentage points to GDP. The Australian Bureau of Statistics said on Tuesday, that private business investment was pushed mainly by a 5.9% increase in new machinery and equipment, while new engineering construction rose 6.6% from the previous quarter.

In its latest quarterly statement of monetary policy released last month, the central bank, said that businesses have been reporting their highest levels of capacity utilization since the late 1980s. Despite the three interest rates hikes last year, the demand for finance strengthened in the first half of 2007, particularly in the business sector, the bank observed.

As a result unemployment in recent months has reached a generational low, the report said. The bank noted that high levels of business investment could contribute to the growth of productive capacity over time. However, it also raised some concern that the higher-than-average pace may further add to capacity pressures in the near term.

Although, wages did not rise significantly in recent months, except in construction and mining, due to scarcity of labor in those sectors, the bank said that the recent prices data indicated a pick-up in inflation.

The quarterly core inflation measures rebounded strongly from their low readings of the earlier two quarters. The core inflation rate rose to 2.6% from 2.5% in the earlier quarter. The trimmed mean inflation was 2.6% up from 2.3%, while weighted median inflation rose to 2.8% from 2.5% over the same period.

Australia's annual inflation stood at 2.9% in August after touching 3.0% in the prior month, according to a survey published by TD Securities and the Melbourne Institute on Monday. On a monthly basis, inflation rose 0.5% in August following a 0.6% increase in July.

Last month, the central bank revised up its inflation outlook of 2007 to 3.0% from its earlier forecast of 2.5%. It expected the underlying inflation to stay near the top of the target range of 2.5 to 3.0% in 2008.

The RBA Governor Glenn Stevens, while giving the customary semi annual testimony before the House of Representatives Standing Committee said on August 17, that the June quarter CPI data showed some pick-up in inflation, which with a stronger growth outlook indicated a higher path for inflation for another one to two years.

"The judgment we reached was that the risk of unnecessarily damaging growth with a modest rise in interest rates was small, whereas the cost of not responding to a deterioration in the outlook for inflation could well, in the longer term, be substantial," the governor said.

Picking cue from his comments a section of market believes that a further rise in the interest rate before the year-end looked firm. Analysts believe that the central bank's future policy stance depends on the degree of impact the U.S. subprime crisis could have on the global financial markets and domestic growth. Additionally, it is believed that any monetary policy tightening could be opposed by the government ahead of the elections, which is scheduled to be held later this year.