Australia Raises Interest Rates: Who’s Next?

Australia, which managed to avoid a full-blown recession amid the worldwide economic downturn, raised its interest rates from 3% to 3.25% on October 6, 2009. It is the first G20 nation to tighten its monetary policy, as well as the only one to see its economy expand in the first half of 2009.

The move was not a complete surprise, although it did come a month or two earlier than most economists expected. The Australian economy saw a slight contraction in the final quarter of 2008, but it recovered quickly and exceeded expectations in the second quarter of this year. Increased commodity prices and Chinese demand for its natural resources helped boost growth.

As long as expansion continues, Australia’s central bank expects to gradually raise rates to about 5% over the next year or two.

The global economy also appears to be recovering, albeit slowly, fueling debate about the wisdom of reversing the support measures enacted last year amid U.S. bank failures and worldwide economic downturns.

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The world’s biggest developed economies are unlikely to follows Australia’s lead any time soon, as recovery remains slow and painful in America, Europe and Japan. The U.S. and Europe both are likely to keep rates low at least until late 2010 and more likely early 2011. The Bank of Japan also has indicated its intention to keep its overnight call rate low – currently at about 0.1 percent – for the foreseeable future.

Countries that managed to avoid the worst of the economic crisis, including Norway and the Asia-Pacific economies of China, Taiwan, South Korea and India, have been expected to raise their rates in the near future. Now that Australia has broken the ice, they may have additional incentive to make that move in the final quarter of 2009 rather than waiting until 2010.

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Many economists see South Korea as the likeliest candidate for tightened monetary policy in the next month or two, as its economy is showing the fastest recovery. One potential stumbling block is the lagging U. S. economy, because the Asian central banks usually wait for the U.S. Federal Reserve to make the first move. In the current economic climate, waiting on the Fed could fuel inflation in Asia, but acting too soon could negatively impact their currencies. Nonetheless, most economists expect both South Korea and Taiwan to move in the final quarter 2009.

Norway, also a resource-rich nation that has avoided the worst of the recession, is expected to tighten monetary policy soon as well. The revitalized commodity sector has aided the worlds’ fifth-biggest oil exporter, and Norges Bank considered a rate increase at its Sept. 23 meeting. While the bank did not move then, it is likely to do so sooner rather than later.

Despite continued weakness in many of the world’s economies, Australia’s tightened monetary policy may be the clearest signal yet of the beginning of the end of the global economic distress.

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[tags] Australia, economic downturn, G20, Chinese, natural resources, bank failures, worldwide economic downturns, America, Europe, Japan, Bank of Japan, Norway, Asia-Pacific, China, Taiwan, South Korea, India, Norway, out-of-the-money, EWY, iShares MSCI South Korea Index ETF [/tags]