Australia Increases Rates, Canada Stays Steady as Both Cast Wary Eyes Toward Inflation

Canada and Australia, two resource-rich nations that are recovering quickly from the global recession, yesterday (Tuesday) reaffirmed interest rate policies as both promised to remain vigilant about rising inflation.

The Reserve Bank of Australia (RBA) raised its cash rate target by a quarter of a percentage point to 4.00%, while the Bank of Canada (BOC) kept its benchmark interest rate at record lows. Both central banks said inflation and economic output have been higher than policymakers expected.

The target rate for overnight loans between commercial banks in Canada will remain at 0.25%, the same level it's been since April 2009, exactly in line with predictions by 22 economists surveyed by Bloomberg News. The central bank also repeated a pledge to leave it unchanged through June unless the current inflation outlook shifts.

The Canadian economy grew at a rate of 5% in the fourth quarter, Statistics Canada said yesterday, outpacing the bank's prediction of 3.3% growth. Inflation has also picked up, accelerating at close to the central bank's 2% target, which has analysts projecting the bank will raise interest rates earlier than previously thought.

"The relative fundamentals of Canada are still there," said Brian Kim, a currency strategist at UBS AG (NYSE: UBS) in Stamford, Connecticut, before the announcement.

The Canadian dollar rose 1.8% last month against the U.S. dollar, posting its biggest monthly gain since November as exports of crude oil, the country's largest export, continued to soar. The loonie appreciated as much as 1% yesterday, the currency's largest daily upswing since Feb. 11.

After policymakers held their last meeting on Jan. 19, BOC officials repeated that the currency's "persistent strength" could hurt the nation's economic rebound.

Rates on the Rise in the Land Down Under

For its part, Australia resumed its tightening policy after it paused in February. The RBA insisted that the latest rate increase is just another response to economic conditions that are returning to normal.

"The board judges that with growth likely to be close to trend and inflation close to target over the coming year, it is appropriate for interest rates to be closer to average. Today's decision is a further step in that process," RBA Governor Glenn Stevens said in a statement.

The rate increase indicates that Australia will continue to lead the Group of 20 (G20) countries — most of which still have rates set close to zero and continue to face weak conditions — in removing stimulus from the economy.

After the country avoided recession in 2009, the RBA was the first central bank in the G20 to start raising interest rates, beginning in October, and then again in November and December. Stevens last week said rates are still 50 to 100 basis points, or hundredths of a percentage point, below normal.

Economists said further rate rises are on the way but expect the RBA to pause every so often. Most expect the bank to boost rates back into levels appropriate for a steadily growing economy, widely viewed to be between 4.25% and 4.75%.

"They are not indicating any urgency," Bill Evans, chief economist at Westpac (NYSE ADR: WBK) told The Wall Street Journal." We think they will go again in a couple of months. It could be three months, it could be two…that may depend on how the inflation numbers look."

Australia's economy is in the midst of a rally, with already-low unemployment causing worry about wage pressures, as demand heats up in areas of the economy like mining and energy. Unemployment fell to 5.3% in January, already above levels economists considered full employment.

Treasurer Wayne Swan noted that while some areas of the economy are weak, mining companies are experiencing a boom.

"If you are in resources, the outlook is quite bright, there's no doubt the economy is strengthening, but if you saw some of the data that came out last week, parts of the economy are still soft," he told The Journal.

News & Related Story Links:

• Bloomberg:
  Canadian Dollar Extends Gain After Central Bank Rate Decision
• Wall Street Journal:
  RBA Resumes Rate-Tightening Policy
• Money Morning:
  Commodities-Rich Australia Leads the West's Recovery