The Reserve Bank of Australia has decided to increase the cash rate by 25 basis points to 4.7 per cent at its monetary policy meeting this month.  The comments below, extracted from the official RBA statement, elaborate on the reasons for the decision.

“The global economy grew faster than trend over the year to mid 2010. Global growth will probably ease back to about trend pace over the coming year as strong recoveries in the emerging world give way to a more sustainable pace of expansion and growth remains subdued in the United States and Europe. At the same time, concerns about the possibility of a larger than expected slowing in Chinese growth have lessened recently and most commodity prices have firmed, after a fall earlier in the year. The prices most important to Australia remain at very high levels, with the result that the terms of trade are at their highest since the early 1950s. The turmoil in financial markets earlier in the year has abated, though sentiment remains fragile.”

“Information on the Australian economy indicates growth around trend over the past year. Public spending was prominent in driving aggregate demand for several quarters but this impact is now lessening. While there has been a degree of caution in private spending behaviour thus far, the rise in the terms of trade, which is now boosting national income very substantially, is likely to lead to stronger private spending over the next couple of years, especially in business investment.”

“Asset values are not moving notably in either direction, and overall credit growth remains quite subdued at this stage notwithstanding evidence of some greater willingness to lend. 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. This will assist, at the margin, in containing pressure on inflation.”

“The demand for labour has continued to firm. While the labour market is not as tight as in 2007 and 2008, some further strengthening would appear to be in prospect, judging by the trends in job vacancies. After the significant decline last year, growth in wages has picked up somewhat, as had been expected. Some further increase is likely over the coming year.”

“Given these conditions, the moderation in inflation that has been under way for the past two years is probably now close to ending. Recent information suggests underlying inflation running at about 2½ per cent, with the CPI inflation rate a little higher due mainly to increases in tobacco taxes. Both results were helped somewhat in the latest quarter by unusual softness in food prices. Inflation is likely to rise over the next few years. This outlook, which is largely unchanged from the Bank’s earlier forecasts, assumes some tightening in monetary policy.”

“For some time, the Board has held the stance of monetary policy steady, which has resulted in interest rates to borrowers being close to their average of the past decade. This allowed some time to observe the early effects of previous policy changes and to monitor the uncertain global outlook. The Board is also cognisant of differences in the degree of economic strength by industry and by region.”

“However, the economy is now subject to a large expansionary shock from the high terms of trade and has relatively modest amounts of spare capacity. Looking ahead, notwithstanding recent good results on inflation, the risk of inflation rising again over the medium term remains. At [its recent] meeting, the Board concluded that the balance of risks had shifted to the point where an early, modest tightening of monetary policy was prudent.”