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Australia has become the first industrialized nation to commence the journey back to a normal monetary policy stance. The Reserve Bank of Australia surprised some analysts with its decision to increase rates by 0.25% to 3.25%. The modest rate hike is the first increase in 18 months and follows the emergency monetary easing executed late in 2008/early 2009 in response to the financial crisis. Currency analysts immediately revised their end of year targets, predicting the end of 2009 rate would be 3.5% and end of 2010 rate between 4.5% and 5.0%. A rate around 5% would still represent a relatively loose monetary policy compared to the 7.25% businesses and consumers suffered at the peak of the last economic cycle.

Extracts from the official RBA announcement, below, highlight the factors behind the rate decision; a stronger than predicted economic recovery and easing deflationary pressures.

The global economy is resuming growth. With economic policy settings likely to remain expansionary for some time, the recovery will likely continue during 2010 and forecasts are being revised higher. The expansion is generally expected to be modest in the major countries, due to the continuing legacy of the financial crisis. Prospects for Australia’s Asian trading partners appear to be noticeably better. Growth in China has been very strong, which is having a significant impact on other economies in the region and on commodity markets.

Unemployment has not risen as far as had been expected. The weaker demand for labor over the past year or so nonetheless has seen a moderation in labor costs. Helped by this and the earlier fall in energy and commodity prices, inflation has been declining, though measures of underlying inflation remained higher than the target on the latest reading. Underlying inflation should continue to moderate in the near term, but now will probably not fall as far as earlier thought.

Source: Australia Wins Global Race to Tighter Monetary Policy