Australia c.bank signals more rate hikes, lifts Aussie

Australia's top central banker flagged more interest rate rises as an economic recovery takes hold, encouraging some investors to speculate the next increase might be a hefty half-percentage point move and sending the Australian dollar to 14-month highs.

Speaking publicly for the first time since a surprise decision to raise the cash rate by a quarter of a percentage point last week, Reserve Bank of Australia (RBA) Governor Glenn Stevens said in a speech on Thursday that the risk of serious economic weakness had abated.

He said holding interest rates at very low levels was no longer needed, and he would not be timid in removing some of the monetary policy stimulus which was put in place to help the economy ward off the worst of the global financial crisis.

"We have said that, over time, interest rates will need to be adjusted towards a more normal setting as the economy recovers," Stevens said.

"A step in that direction was taken last week.

Last week, the central bank 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 .

But after Stevens' comments on Thursday, investors were factoring in a nearly 35 percent chance of an unusual 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 rose after the governor's comments to $0.9195 from $0.9160 while swap rates jumped as investors priced in more chances of rate hikes in coming months.

Interbank futures <0#YIB:> were 0.075 points down to imply a one-month rate of 3.815 percent, and overnight indexed swaps jumped to 4.5025 percent from 4.395 percent. That was the highest level since Nov 3.

Stevens has declined to say what a "normal" rate 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 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.

Holding well

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.

In conducting monetary policy during this expansion, the RBA's objectives would be to keep inflation low, he said.