Monetary policy: Australia's central bank surprises with the strongest rate hike in 22 years

In its fight against high inflation, the Australian central bank has surprisingly raised its key interest rate more than it has in 22 years.

The Reserve Bank of Australia (RBA) announced an increase from 0.35 to 0.85 percent on Tuesday.

Most investors and economists had only expected a small step up of 0.25 or 0.40 points after the key interest rate was raised in May for the first time since 2010 - by a quarter of a percentage point.

"Given the current inflationary pressures in the economy and the fact that interest rates remain very low, the board has decided to raise interest rates by 50 basis points today," said RBA Governor Philip Lowe.

"The board expects to take further steps to normalize monetary conditions in the coming months."

The Australian dollar peaked half a percent higher at $0.7248 before falling on profit-taking.

A higher interest rate makes the currency more attractive to investors.

If it appreciates, it can make imports cheaper and thus reduce price pressure.

Loans are also becoming more expensive, which can dampen demand and thus inflation.

Inflation hit a 20-year high of 5.1 percent in the first quarter.

In the current spring quarter, it could approach the six percent mark, since energy, groceries and rents in particular have become more expensive.

"Higher electricity and gas prices and the recent rise in petrol prices mean that inflation is likely to be higher in the near term than was expected a month ago," Lowe said.

With inflation likely to stay high for some time, investors are betting that the central bank will have to hike interest rates to nearly 3% by year-end.

According to experts, the European Central Bank (ECB) will prepare the ground for the first rate hike in eleven years this week.

As an important prerequisite for this, the end of the multi-billion dollar bond purchase program APP should be sealed at the external ECB meeting in Amsterdam on Thursday.

This is seen as a precursor to the rate hike that is likely to follow in July.

(Report by Wayne Cole, written by Rene Wagner, edited by Sabine Ehrhardt - If you have any questions, please contact our editorial team at berlin.newsroom@thomsonreuters.com)