News

When it comes to seeking a path back to normalcy, even the boldest central banks are stepping gingerly.

After the Reserve Bank of Australia surprised many last month by becoming the first major central bank to increase interest rates since the since the start of the financial crisis, some investors bet Governor Glenn Stevens would bushwhack his way to higher rates to keep record-low borrowing costs from stirring inflation.

Instead, Mr. Stevens is proceeding cautiously.

Even though the Australian government raised its economic growth forecast for the current fiscal year by 2 percentage points, Mr. Stevens reinforced his pledge to "lessen gradually" the amount of monetary stimulus in the economy by increasing the benchmark lending rate by only a quarter of a percentage point.

That's the equivalent of a baby step in central banking, highlighting how difficult it is for policy makers to get a read on a global recovery that is still so far dependent on rock-bottom borrowing rates and hundreds of billions of dollars in government spending.

Finance ministers and central bankers are still waiting for clear signs that private demand is replacing government stimulus, and they are never certain how markets will react to their various decisions. In explaining his decision to opt for a second consecutive quarter-point increase, Mr. Stevens cited the probability that stimulus-fuelled purchasing of houses and other goods will subside and the likelihood that the strong Australian dollar will constrain the export of factory goods.

"The board noted that the rise in the exchange rate is likely to constrain output in the tradeables sector and dampen price pressures," Mr. Stevens said in the statement explaining the central bank's decision.

The mere mention of the dollar in a Reserve Bank of Australia statement was significant because Mr. Stevens tends to avoid any commentary that could influence foreign-exchange markets. His September statement sidestepped the currency issue, creating the impression that the central bank expected that demand from China and Australia's other Asian trading partners would offset any gains in the exchange rate.

The Australian dollar is one of the world's strongest currencies, in large part because of Mr. Stevens's monetary policy. The benchmark rate is 3.5 per cent, compared with an official rate that is near zero in the United States and 0.25 per cent in Canada, making Australia an attractive choice for international investors seeking higher yields.

Australia's currency has surged almost 30 per cent in the past 12 months against its U.S. counterpart, the biggest increase among 171 currencies tracked by Bloomberg.

"What was unexpected was their caution about the strength of the Australian dollar," said Mark Chandler, a fixed-income strategist at RBC Dominion Securities in Toronto. "What gets the central banks a little worried is they don't have a good feel for the lags in how currency strength feeds through to the economy."

The Australian dollar dropped to as low as 89.17 U.S. cents yesterday from almost 91 cents before the decision. The yield on the two-year government bond dropped 18 basis points to 4.55 per cent, an indication that investors are less confident Mr. Stevens will raise borrowing costs as quickly as previously anticipated. (A basis point is 1/100th of a percentage point.)

Traders pared their bets that Mr. Stevens will increase borrowing costs again next month. Based on the price of contracts for future interbank rates on the Sydney Futures Exchange, Bloomberg News calculated yesterday that investors reckon there's a 58-per-cent chance the Reserve Bank of Australia will increase the cash rate another quarter-point on Dec. 1, compared with 96 per cent before Mr. Stevens's latest comments.

Australia is the lone member the Group of 20 economic powers to raise interest rates this year, and is the only country whose central bank has increased borrowing costs more than once.