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Rates set to hit a 10-year high today

ANALYSIS: Scott Murdoch | November 07, 2007

SHORT-TERM interest rates in Australia hit new highs yesterday in anticipation of a near-certain 25 basis points lift in interest rates by the Reserve Bank this morning.

The forecast interest rate rise to 6.75 per cent will still fall short of the real level of short-term rates, which suggests there is a strong chance of a further official rate rise in the next two months.

The yield on the 90-day bank bill shot up to 7.12 per cent yesterday, and analysts said this was a sign of short-term credit stress re-emerging.

Banks are coming under pressure to raise rates by more than 25 basis points because of the rising cost of funds, despite exhortations from Treasurer Peter Costello not to do so.

But even banks that have said they might do that -- such as NAB -- have made it clear they hope not to do it on this occasion.

The jump pushed the bill rate past the 7.0983 per cent seen on September 12 when global markets were struggling with illiquidity in the wake of the sub-prime meltdown in the US.

Traders blamed the latest shake-up on Wall Street investment banks, particularly Citigroup, which has reignited fears of further writedowns on the back of the sub-prime crisis.

The Reserve Bank pumped $1 billion into the money markets yesterday in a bid to ensure there is sufficient liquidity for the major trading banks.

The shot of cash is the most injected by the RBA in recent weeks, but economists believe the action is not enough to keep the cash rate from rising today.

The RBA met in Sydney yesterday and the decision will be announced today.

The majority of economists have predicted a 25 basis point shift in official interest rates to 6.75 per cent -- the highest level for a decade.

The increase will mean mortgage rates will be raised to 8.57 per cent, which is approaching the highest level in 11 years. But it is regarded as very unlikely that any bank will break ranks and push rates up by more than 0.25 per cent.

Grange Securities chief economist Stephen Roberts said that despite the spike in bill yields, it was not enough to stop the RBA.

"It's part of the contagion of the credit crunch story in the US, because the write-offs are bigger than first thought," Mr Roberts said.

"The money put into the system by the RBA is a bit on the heavy side. That suggests there is still some stress in local markets. There are still some banks that must be looking for short-term liquidity. There is still some difficulty in credit markets.

"Part of the rise in yields is interest rate expectations."

The futures market is pricing the prospect of a rate hike today at 92 per cent but is awaiting the statement that will accompany the increase. Some economists believe a "back-to-back" increase in December is needed to cool the economy.

The forecast increase is expected to give strength to the equities market today but could soften the run of the currency. Last night, as the major international currency trading sessions came online, particularly London, the dollar was slightly higher at US92.29c.

ANZ senior currency strategist Tony Morriss said the softness on the US equities markets had dampened sentiment towards the currency.

"There is greater uncertainty around the risk and the relationship with the share markets," he said.

"I think we are range trading ahead of the RBA decision, but there's also scope for the market to be disappointed with the statement."

Economists are known to be planning to scour the RBA's announcement today for any hint of further rate rises.

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