Inflation concern led to RBA rate rise

THE Reserve Bank decided to lift interest rates in October due to worries about inflation and to prevent any build up of "imbalances" in the economy, the latest board minutes reveal.

The Reserve Bank lifted its interest rate last month to 3.25 per cent. Graphic: Eric Auld

THE Reserve Bank decided to lift interest rates in October due to worries about inflation and to prevent any build up of "imbalances" in the economy, the latest board minutes reveal.

The central bank lifted the cash rate to 3.25 per cent after its monthly board meeting on Tuesday, October 6, from three per cent. It was the first increase in the cash rate since March 2008.

The minutes of the meeting show that board members had debated the merits of increasing the cash rate in October or keeping it steady, but concluded that "the risks in waiting had increased" as the economic outlook improved.

"Members concluded that, while downside risks to the domestic economy could not be ruled out, they had diminished significantly over recent months," the minutes, published today, said.

"This meant that the balance of risks was now such that the current very expansionary setting of policy was no longer necessary, and possibly imprudent.

"The board therefore decided in favour of raising the cash rate."

On inflation, board members noted that underlying inflation was still above the central bank's two to three per cent target range.

While it was forecast to fall "the expected trough in inflation was significantly higher than earlier thought".

"Keeping interest rates at very low levels for an extended period could therefore threaten the achievement of the inflation target over the medium term," the minutes added.

"More generally, very expansionary policy could result in the build-up of other imbalances in the economy, which would ultimately be detrimental to economic growth."

Inflation "could be rising again" by 2011, the minutes said.

The September consumer price index will be published next week.

The minutes provided few clues about the timing and size of any potential future moves.

But board members repeated sentiment expressed at previous meetings that "if the prospects for the economy continued to strengthen, in due course there would be a need to adopt a less expansionary monetary policy stance".

Regarding the domestic economy, the minutes said that "absent further setbacks" gross domestic product growth could be close to trend through 2010 and "subsequently .

Board members also discussed the RBA staff's latest forecasts and risks around the outlook.

"The forecasts assumed a rise in the cash rate over the year ahead," the minutes said.

Board members also discussed the risks that a move in October would be "premature", noting that a rising Australian dollar exchange rate would hinder activity and help contain inflation.

The minutes also said that the risk of another downturn in some countries could not be ruled out, given the economic prospects for most of the developed world were "still uncertain".

Moreover, there was a risk domestic activity might slow as the "greater-than-expected" impact of the fiscal stimulus measures faded.

"These considerations weighed in favour of keeping the current policy setting for a while longer so as to evaluate further data," the minutes said.