RBA's Stevens gives world economy "all clear"

CANBERRA, Oct 9 AAP

October 09 2009, 4:10PM

Business and unions say it was premature, most market economists thought it would be in another month, and retail banks took an age to decide what to do about it.

The federal opposition unsurprisingly blamed the government, but then got sidetracked by leadership speculation and resignations.

And the government said it shouldn't be a surprise to anyone ... except the Liberals.

Welcome to the new era of rising interest rates.

The Reserve Bank of Australia (RBA) decision to go boldly where no other G20 country has gone - being the first to raise its key interest rate since the onset of the global recession - may have caused some initial hand-wringing.

But in the wake of Thursday's surprisingly strong labour force report it appeared justified.

Sadly for borrowers, but good news for savers, it also made further rate hikes likely at both the November and December RBA board meetings.

And further ahead, we could be looking at a cash rate of five per cent by this time next year, according to current money market pricing.

Announcing the 25 basis point increase in the cash rate to 3.25 per cent - the first rise in 19 months - RBA Governor Glenn Stevens said the basis for reductions in late 2008 and early 2009 had "now passed".

Effectively calling the "emergency" over led to a rally on Wall Street - a rare event of the tail wagging the dog.

"We have long argued that Australia is the canary of the global economy," RBC Capital Market senior economist Su-Lin Ong said.

"If the Australian economy kept singing then it was likely that the world economy would avoid falling in the abyss."

That's because Australia is an indicator of the health of the global economy, given its status as a commodity economy and because of its close relationship with the growing economic powerhouse of China, she said.

So the fact that Mr Stevens has given the 'all clear' suggests the global economy is in recovery.

Responding to the central bank's decision, Treasurer Wayne Swan said he understood it would make it tougher for families with a mortgage but he thought few households would be "surprised" by the move.

Whether or not it was a surprise should show up in next Wednesday's consumer confidence survey from the Westpac and the Melbourne Institute.

But Mr Swan said it was a consequence of Australia outperforming other advanced economies.

Before the RBA did the deed, the opposition had argued that there was no justification for rates to rise given the cash rate - even at a 49-year low of 3.0 per cent - was still higher than other leading countries.

But Mr Swan said the opposition's approach to interest rates lacked credibility and suggestions that rates could stay at record lows were "simply laughable".

"Clearly, commonsense will tell you that as the economy begins to recover, the Reserve Bank will exercise its independence and move rates accordingly," he said.

Still, business groups are miffed that rates are already on the rise when small business in particular only got a proportion of the 425 basis points of rate reductions.

Unions too thought the increase was premature given there are 1.5 million people either out of work or looking for extra working hours.

But addressing a Senate committee inquiry into the government's stimulus spending on Friday, a Treasury official said there were dangers in leaving interest rates at low levels for an extended period of time.

The executive director of Treasury's macroeconomic group, David Gruen, said the "global mess" the world found itself in had followed an extended period of ultra-low interest rates in the United States.

"We can debate how bigger a contributing factor that was, but it is certainly the case that a considerable body of opinion suggests ... (they) were a significant contributing factor in the housing price bubble that developed in the US," he said.

The idea that only cutting interest rates further and for longer had benefits was an argument that many people - including Mr Stevens - would not agree with, Dr Gruen said.

Surprisingly, it took the major retail banks two days to decide what impact the 25 basis point increase would mean for their standard variable mortgage rates.

It looked like a simple equation, unless, of course, they were thinking of going by more, or - but more unlikely - less.

In the event, they matched the official move, adding around $45 to a monthly repayment on an average $300,000 home loan.

Mr Swan said homeowners with an average mortgage were still some $700 a month better off than they were last August and before rates were slashed.

Of course, that doesn't include the 150,000 first home buyers that have so far taken up the government's more generous housing grant that has been in place since October last year.

Let's hope they aren't having second thoughts about the dream of home ownership.

By Colin Brinsden, Economics Correspondent

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