Published October 7, 2009

Australia raises interest rates, will Seoul follow?

Analysts also focus on Norway, Canada and New Zealand for next rate move

By OH BOON PING

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(SINGAPORE) The first of the interest rate hikes has arrived. The Reserve Bank of Australia yesterday raised its central rate by 25 basis points to 3.25 per cent and signalled further increases amid signs the economy is strengthening.

The rate rise is the first by a G-20 country since the start of the global financial crisis and has triggered talk that other countries may follow suit.

'It's quite a pre-emptive move,' RBC Capital Markets senior economist Su-Lin Ong told Bloomberg.

'They're very comfortable the globe is returning to firmer growth, particularly Australia's key trading partners in Asia.'

The Australian dollar rose to 88.53 US cents yesterday afternoon, from 87.62 cents just before the rate rise was announced.

RBA's move comes amid a general recovery in equity markets and speculation that a rate hike was inevitable.

In the 24 hours prior to the official announcement, yields on short-term interest rate futures rose sharply, with the three-month Aussie dollar overnight interest swap rate up 10 basis points to 3.36 per cent.

'The market was thus fully priced for a 25 basis points hike by the RBA,' said RBC strategist Matthew Strauss.

Trading in overnight index swaps suggests traders are pricing in the likelihood that the RBA will raise rates by 175 to 200 basis points over the next 12 months, according to some players.

Explaining RBA's move, governor Glenn Stevens said that interest rates were dropped to a very low level in late 2008 and early 2009 on expectations of 'very weak economic conditions and a recognition that considerable downside risks existed'.

But according to him: 'The basis for such low interest rate settings has now passed.'

Although he acknowledged that some areas of demand may stumble, the central bank is confident that 'growth is likely to be close to trend over the year ahead and inflation close to target', he said, adding that 'the risk of serious economic contraction in Australia has passed.'

RBA's decision was announced against a seemingly unsupportive backdrop. Australia's trade deficit narrowed to A$1.5 billion (S$1.9 billion) in August from a revised A$1.8 billion the previous month.

Imports fell 2.9 per cent, led lower by a 24 per cent drop in inbound fuel and lubricant shipments. This outpaced a 1.8 per cent decline in exports due to a sharp drop in coal sales.

RBC said in a report: 'Now that the cycle of global loosening is broken, Norway will almost certainly be next at the end of this month, and attention will turn to Canada and New Zealand.'

'With other cyclical countries hiking, the Bank of Canada and Reserve Bank of New Zealand's commitments to keep rates unchanged until mid-to-late 2010 respectively may begin to look untenable and there is scope for NZ and Canadian dollar rallies as those hikes are priced in.'

News of Australia's rate rise triggered an equities sell-off in Seoul, where the Kospi dropped 0.53 per cent at one point and closed lower for a fourth consecutive session.

'The rate hike by Australia, which came far earlier than expected, weighed on sentiment as it pointed to the possibility South Korea may be next to raise rates,' said Lee Sun-yeop, a market analyst at Shinhan Investment Corporation.

Foreign investors were sellers of a net 28 billion won (S$33.6 million) of stocks, off-loading Seoul shares for an eighth consecutive session. But they remain net buyers of 4.3 trillion won so far this year, after a non-stop buying streak from March to September.

'Foreign investors are not selling out massively and I do not think their selling will be an established trend,' Mr Lee said. 'But without foreign buying, markets are faced with lack of buying activity as institutions are selling as well, amid equity fund redemptions.'

Indonesia's central bank kept interest rates unchanged for a second month on Monday, while the US Federal Reserve left the rate for overnight loans between banks at a record low of between zero and 0.25 per cent on Sept 24.