RBA raises rate as economy proves stronger than expected

On Tuesday, the Reserve Bank of Australia raised its benchmark interest rate, becoming the first among the Group-of-20 economies to do so since the global recession began to show signs of easing.

During its monetary policy meeting, the RBA decided to raise the cash rate by 25 basis points to 3.25 percent.

In his statement following the meeting on Tuesday, RBA governor Glenn Stevens said that the "global economy is resuming growth" and "the recovery will likely continue during 2010". In Australia, economic conditions have been "stronger than expected" and inflation "will probably not fall as far as earlier thought". Therefore, he said that it is "now prudent to begin gradually lessening the stimulus provided by monetary policy".

The Australian economy had contracted by 0.7 percent in the fourth quarter of 2008 but grew by 0.4 percent and 0.6 percent in the first and second quarters of this year respectively. Consumer prices rose 1.5 percent in the year to June 2009.

RBA staff forecasts prepared for the August monetary policy meeting had revised 2009 GDP up to show a rise of 0.5 percent instead of the previous 1 percent decline.

In its latest World Economic Outlook released in October, the International Monetary Fund said that "Australia is on its way to recovery". It expects the Australian economy to grow 0.7 percent in 2009, much better than the 1.4 percent decline in its April report.

Past and -- Tuesday's rate hike notwithstanding -- ongoing monetary stimulus is likely to keep the economy on an expansion path. The spread between 10-year government bonds and the cash rate had surged to over 2 percent around the middle of this year. Historically, such a surge has often been followed by rapid economic expansion.

While the first in the G-20 to raise interest rates, the RBA is not the first central bank to raise rates in this cycle. That honour goes to the Bank of Israel, which had raised interest rates back in August.

The rate hikes from these two central banks, however, are not likely to start a widespread trend. Other central banks are likely to take their time in tightening monetary policy. The IMF's forecasts show that Australia is the only advanced economy expected to register positive growth this year while Israel's economy is expected to contract by just 0.1 percent, the smallest decline among the rest. Furthermore, the IMF also said in its report that risks to the global economic outlook remain "on the downside" and that premature exit from accommodative monetary and fiscal policies is "a particular concern".

No doubt, that concern is shared by the most important central bank of all, the Federal Reserve. At its last monetary policy meeting, it had said that economic conditions warrant "exceptionally low levels of the federal funds rate for an extended period". So don't expect interest rate hikes there.

So despite the latest move by the RBA, rate hikes by central banks are likely to remain the exception rather than the rule in the near future.