Australia Rate Hike A Good Sign For World Economy

A move by Australia's central bank to raise its benchmark interest rate, the first major economy to do so since the financial crisis worsened last fall, may signal a vote of confidence in a global recovery.

Still, most economists don't expect the Federal Reserve or other major central banks to follow Australia's lead and raise rates anytime soon. Australia's economy is healthier than the U.S. or European economies, due to rising prices for metals and other commodities it produces.

But the decision by the Reserve Bank of Australia to reverse some of the steep rate cuts it implemented last year is a sign the economy is improving in parts of the world, analysts said. A healthier world economy could help the United States by boosting exports.

"Recovery is starting to take hold" in Asia, said Jay Bryson, global economist at Wells Fargo Securities. "Very low interest rates there may not be necessary for much longer."

Australia's central bank governor, Glenn Stevens, said Tuesday the risk of "serious economic contraction" in that country had passed. Australia is benefiting from a strong rebound in China, a major trading partner that imports huge amounts of Australia's iron ore and other minerals. Its economy grew in the first two quarters of this year, when the U.S. economy remained mired in recession.

The move helped boost the U.S. stock market. The Dow Jones industrial average jumped about 132 points, while broader indexes also increased.

Australia's move comes after the International Monetary Fund said last week the global economy is recovering faster than expected. The IMF raised its estimate for world economic growth to 3.1 percent in 2010, from a previous forecast of 2.5 percent.

Among major economies, Norway is the most likely candidate to raise rates this year, analysts said, as high oil prices bolstered its economy. The country's central bank could boost rates as soon as its next meeting on Oct. 28.

South Korea is another likely candidate, according to Benjamin Reitzes, an economist at BMO Capital Markets in Toronto. The country's central bank has already noted rising home prices and said it might raise rates in response, he said.

Asia is recovering so quickly that some analysts worry it could face asset bubbles and a spike in inflation if governments wait too long to withdraw stimulus measures. Rising food prices already are becoming a problem in India. HBSC economists said in a report Tuesday that South Korea, Indonesia and the Philippines are particularly vulnerable to an inflation blowout.

Still, when it comes to higher rates, "Australia may prove to be an isolated case," said Geoffrey Yu, a London-based currency strategist for UBS, given its much stronger recovery. Its economy grew at a 2.5 percent annual rate in the April-June quarter, Reitzes said, while the U.S. economy shrank at a 0.7 percent rate.

One restraint on many countries will be exchange rates, several analysts said: if they get too far ahead of the Federal Reserve, their currencies will rise relative to the dollar, as investors seek out higher interest rates. That, in turn, would make their exports to the U.S. more expensive.

That will cause some countries, such as Switzerland, Canada and New Zealand, to delay raising rates for as long as possible, Yu said.

The Federal Reserve, which has pumped over $2 trillion into the economy to spur lending and boost consumer spending, isn't expected to raise the interest rate it controls until sometime next year, at the earliest. The rate is currently at a record low near zero.

William Dudley, president of the New York Fed, on Monday reiterated that the central bank will keep rates "exceptionally low ... for an extended period."

Both the European Central Bank and the Bank of England, meanwhile, are expected to keep their benchmark interest rates at their respective historic lows of 1 percent and 0.5 percent when thy announce their decisions Thursday.

Most analysts think that the ECB, which sets monetary policy for the 16 countries that use the euro, is comfortable with the notion of keeping interest rates at very low levels for a protracted period.

Last week, the ECB's president Jean-Claude Trichet indicated that it is too early to consider raising interest rates. The IMF is predicting that output in the 16 eurozone countries will shrink 4.2 percent in 2009, even though official figures show that the recession in France and Germany is over.

Italy, Ireland and Spain are still struggling. Spain suffered a major housing boom and bust, and its unemployment rate is almost 19 percent.

When world leaders from the Group of 20 major developed and emerging economies, including Australia, met in Pittsburgh late last month, they pledged to maintain low interest rates and other stimulative measures. They also agreed to coordinate the reduction and removal of those measures.

But Yu said most central banks will set interest rates in response to domestic needs, while coordinating on other measures, such as unwinding emergency lending programs that support banks.

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AP Writer Pan Pylas in London contributed to this story.

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