Rates rise but no one should be surprised

Reserve Bank Governor Glenn Stevens has been hinting heavily that Australia's economic emergency is over, and that rates therefore no longer need to be kept at "emergency levels".

The Reserve Bank's board has now backed that up with a quarter of a percentage point rise in the central bank's cash rate, from three per cent to 3.25 per cent, setting the stage for a round of increases that will carry all rates significantly higher.

As the global crisis expanded, the Reserve cut its cash rate from 7.25 per cent to three per cent between September last year and April this year. Now, with the economy recovering, they are headed back to what Stevens calls "normal" levels: that's around five per cent, and the Reserve will almost certainly increase the cash rate again before Christmas.

In his statement explaining today's decision, Stevens says that growth appears to be returning to the long-term trend, and the risk of a "serious contraction" appears to have passed.

With inflation always a threat given the stimulus rates and government spending have delivered, he says the board's view is that it is "prudent to begin gradually lessening the stimulus provided by monetary policy." That suggests a steady rate of increase - the five per cent marker may be more than a year away - and it is possible because the Reserve is moving early to prevent the economy and inflation overheating.

The Australian dollar, already strong, shot up on the rate news as expected, but shares will be both pushed and pulled.

That is positive for companies generally because it confirms that the Reserve believes the Australian economy is on the mend. Stevens told a Senate committee last week that a rise should be welcomed for that reason.

But higher cash rates will not only boost the cost of home loans, business loans and other loans, it will also see returns on fixed interest investments ratchet up. That's a welcome development for many investors: but it will make share dividends relatively less attractive compared with fixed interest, and is in that sense a weight on share prices.

The sharemarket did lose some of its modest gains this afternoon when the rate rise was announced.

Then it began to climb back, however, and I suspect the the bigger picture of the Reserve responding to Australia's economic strength will be the one that resonates best.