Australia raises interest rates

November 2, 2010, 6:04 PM UTC

All eyes may be on the Fed, but not all central bankers are on the same page.

The Reserve Bank of Australia raised its key interest rate, known as the cash rate, to 4.75% from 4.5% on Tuesday, warning that inflation is in danger of coming out of a two-year-long hibernation. India’s central bank, facing a more advanced inflation problem, raised rates as well.

Australian for U.S. dollar selloff

Australia’s move shows the governor of the Reserve Bank, Glenn Stevens, taking action to head off a problem that his counterparts at other central banks can only wish they had: a robust economic expansion that’s making workers scarce and pushing up wages.

“The economy is now subject to a large expansionary shock from the high terms of trade and has relatively modest amounts of spare capacity,” Stevens said in Tuesday’s statement. “Looking ahead, notwithstanding recent good results on inflation, the risk of inflation rising again over the medium term remains.”

Australia’s decision will only add to the upward pressure on the Australian dollar, whose value has surged since midyear as the outlook for U.S. growth has waned and Federal Reserve officials have taken to promising that they will do whatever it takes to bolster the flagging domestic economy.

The market has taken that promise to mean the Fed will serially devalue the U.S. dollar, a bet evident in its 18% plunge against the Australian dollar since June. The Australian dollar now trades at parity with the U.S. dollar, a level not seen in at least 17 years.

For now, that’s good news for Australian policymakers intent on holding down prices. Australia has spent recent years cashing in on a commodity boom driven by growth in emerging economies such as China, and by all accounts that trade looks like a good bet to keep working for a bit.

By raising rates at home, the central bankers hope to keep the boom from spinning out of control – though there are some worrisome signs that Australia’s housing bubble is taking on a life of its own.

“The exchange rate has risen significantly this year, reflecting the high level of commodity prices and the respective outlooks for monetary policy in Australia and the major countries,” Stevens said. “This will assist, at the margin, in containing pressure on inflation.”

But only at the margin, which is why a rising rate in Australia now is “prudent,” Stevens said. What Ben Bernanke, who admittedly is cleaning up after a mess partly of the Fed’s making, might give to be able to say the same thing.