The Reserve Bank said today's rise in interest rates was the start of a gradual tightening in monetary policy.
The board of the RBA announced that it will lift the official cash rate by 25 basis points to 3.25 per cent - the first rate increase in Australia since March 2008 and the first of the G20 central banks to raise rates in the wake of the global financial crisis.
Financial markets price about a 74 per cent chance of another rate rise next month.
The bank's governor, Glenn Stevens, said the Australian economy's growth in the next year was now forecast to rebound strongly which meant higher interest rates were needed to ensure the expansion was sustainable.
“With growth likely to be close to trend over the year ahead, inflation close to target and the risk of serious economic contraction in Australia now having passed, the board's view is that it is now prudent to begin gradually lessening the stimulus provided by monetary policy,” Mr Stevens said in a statement accompanying the bank’s decision.
“This will work to increase the sustainability of growth in economic activity and keep inflation consistent with the target over the years ahead.”
The increase could add up to $200 a month to the repayments of an average mortgage and economists now expect the RBA to order further rate hikes in the months ahead.
The big four commercial banks – Westpac, Commonwealth Bank of Australia, National Australia Bank and ANZ – said they were reviewing their interest rates in response to the RBA’s decision.
Treasurer Wayne Swan has warned homeowners to brace for more mortgage pain.
“The Reserve Bank has flagged there could be more to come. Rates can't stay at emergency levels forever,’’ he said.
The prospect of the RBA lifting the official cash rate today was considered a line-ball call by the financial markets, which had judged the chance of a hike at 55 per cent.
The increase comes after a rush of stronger than expected data, showing the Australian economy has rebounded robustly from the financial market upheaval over the past year.
Retail sales during August rose 0.9 per cent, which was almost double the market's forecast of 0.5 per cent, and ended two months of sales contraction.
Economists said the positive bounce showed Australian consumers were becoming confident about their future and the news was complemented by a surge in vacant job positions as compiled by ANZ.
Mr Stevens also said sentiment in global financial markets had improved since the crisis was exacerbated by the collapse of Lehman Brothers in September last year.
The Australian economy, he said, had escaped a technical recession and the nation's reliance on China as a major trading partner would help the economy's growth projection.
“Economic conditions in Australia have been stronger than expected and measures of confidence have recovered,” Mr Stevens said.
“Some spending has been brought forward by the various policy initiatives.
“Unemployment has not risen as had been expected. The weaker demand for labour over the past year or so nonetheless has seen a moderation in labour costs.''
Despite the justification for the rise, Mr Stevens also highlighted that some types of capital spending would remain weak but private investment among business would be better than initially forecast.
The Australian dollar rallied on the tightening of monetary policy, as the hike increased the differential between Australian rate levels and the rest of the world.
The local currency bounced from US87.60c to US88.34c -- the highest level since August last year.
Analysts expected the rates move to drive the Australian dollar towards US90c, because Japan and the US are not forecast to move their key lending rates from virtually zero.
The rates rise has sparked concern, however, from market participants that the increase could dent the positive sentiment towards the Australian sharemarket and housing sector.
“In our view, this afternoon's 25 basis points rise from the RBA is both extraordinary and unnecessary, especially given the RBA clearly had ample time and scope to delay rate hikes until after Christmas,” IG Markets analyst Ben Potter said.
“With government stimulus clearly past its peak and the RBA suggesting itself there were no present imbalances in the economy, we cannot fathom today's decision especially considering the global rhetoric from the recent G20 meeting that it’s too early to begin withdrawing stimulus and normalising rates.''
Harley Dale, chief economist of the Housing Industry Association, said there was now a worry that consumer confidence could be hurt which would hold back the economic recovery in Australia.
“There is a big risk that the increase in official rates will blunt consumer and business confidence that is crucial to the prospects for an economic recovery,” he said.
“Although there are some encouraging signs the economy has avoided falling off a cliff, it is still far too early to call an economic recovery.
“It was not that long ago we were told that Australia faced the worst economic conditions since the Great Depression. Either that assessment was a dramatic overstatement or the Reserve Bank has miscalculated.''
