Royal Bank of Australia Keeps Rates on Hold, Surprises Market

The Royal Bank of Australia (RBA) overnight released its November interest rate decision and unexpectedly kept rates on hold. The RBA kept the benchmark cash lending rate at 3.25 percent in November, defying economist expectations of a 0.25 percent cut to 3.00 percent. The holding of rates follows October's decision where the Bank unexpectedly cut rates by 25 basis points.

In fact, only one economist of the 27 surveyed by Bloomberg has predicted the previous two decisions accurately. The economists at ANZ bank predicted that the RBA would cut rates in October and keep them on hold in November. The RBA cited recent upticks in inflation and better signs out of China as reasons for keeping rates on hold.

The RBA was slightly concerned with recent inflation data coming in higher than expected, a key reason for keeping rates on hold, but also noted that wage growth remains low. Generally, inflation can not take off unless wages, which are regarded as "sticky" by economists, start to inflate. Thus, the lack of wage growth could mean that the spurt in inflation is transitory and not fundamental.

The Bank also noted that China appears to be bottoming along with the rest of the economy. In its post-decision communique, the Bank said that Chinese growth has stabilized. The RBA has a unique view of the Chinese economy both due to its geographic proximity but also because of the trade ties between Australia and China through raw materials. Thus, these comments should not be taken lightly and could confirm recent data trends that China is bottoming or has in fact already bottomed.

Officials were concerned about the strength of the domestic currency and of commodity prices though. The RBA members warned in the communique that the Aussie dollar remains strong, one reason that exports have stayed lower than anticipated. Also, the bank is worried about commodity prices being lower than they were this year, as a large portion of Australia's economy is reliant on strong exports of raw materials.

An interesting fact to note about the lack of a rate cut is that, although economists were expecting a cut, the market was decidedly in disagreement with the economists. Using interest swaps to extrapolate the chances of a cut just before the release of the statement, the market had only priced in approximately a 45 percent chance of a cut in rates. Therefore, either traders knew something that economists did not know or that the Aussie swap traders were simply just smarter than their forecasting cousins.

The Aussie dollar rallied markedly on the news and the Australian stock market outperformed other Asian bourses. The Aussie dollar popped from near 1.0360 to near 1.0420 against the U.S. dollar on the release and has traded higher since. Currently, the pair trades at 1.0433, just below resistance and stops at 1.0450. Also, the EUR/AUD cross dropped to the lowest level since early September on the release as Aussie strength weighed on the euro. The Aussie also gained against the Japanese yen as investors piled into the carry trade, getting the higher than expected yield in the Aussie as a rate cut would have meant lower interest on deposited currency.

Australian stocks also showed relative outperformance in Asian trading. The S&P ASX Index rose 0.24 percent overnight while other regional indexes suffered losses on global growth and European fears. For comparison, Chinese stocks fell 0.38 percent overnight and Japanese shares also fell 0.36 percent.

Materials stocks rose slightly in U.S. trading at the open on the largely positive comments from the RBA. The Materials Select Sector SPDR XLB rose 0.17 percent and notable out-performers included Rio Tinto PLC RIO and BHP Billiton PLC BBL, which each rallied nearly 1.0 percent at the New York open. Freeport-McMoRan Copper and Gold FCX also rallied, but not as strongly as its British competitors.