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Australia Speeds Ahead in Q2, Rate Brake Eyed

Australia's economy sped ahead in the second-quarter as a boom in business and government spending outstripped all expectations, reviving speculation interest rates could have to rise yet further to curb inflation.

The Australian dollar jumped while bill futures slid as gross domestic product (GDP) rose 0.9% in the three months to end-June, breezing past forecasts of a 0.6% increase.

Annual growth accelerated to 4.3% its fastest pace in three years, from 3.8% in the previous quarter.

"This economy is on fire," said Joshua Williamson, a senior economist at TD Securities. "This is the third strong quarterly GDP number that we have had."

The economy grew 1.6% in the first quarter and 1.1% in the last quarter of 2006.

However, such rapid growth carried risks for inflation, which had already picked up notably in the second quarter and forced the Reserve Bank of Australia (RBA) to lift interest rates to a decade high of 6.5%.

The central bank holds its September policy meeting on Tuesday and is still expected to keep rates unchanged given the recent turmoil in credit markets had clouded the outlook for the global economy.

However, the startling pace of growth in the second quarter combined with signs of a reacceleration in consumption for July and August has greatly raised the stakes for rates.

"Obviously we've got a very strong economy on our hands," said Rob Henderson, chief economist markets at nabCapital.

"That continues to underline the risk of excessive growth ahead and the potential that the RBA will need to move further to slow the economy down," he added.

TD's Williamson was even more emphatic.

"We are bringing forward our expectations for a rate hike from February to November," he declared.

Investment Boom

Overall, the inflation-adjusted value of goods and services purchased in the quarter climbed to A$242.7 billion ($199 billion), keeping the economy on course for its first
trillion-dollar year.

Leading the way in the second quarter was business investment, with a hefty 0.7 percentage point contribution to growth. Much of that has come in the mining sector, which is expanding fast to meet demand from China and the rest of Asia.

That strength was welcomed by Treasurer Peter Costello who is hoping the expansion in capacity will help relive some of the upward pressure on inflation over time.

"We are raising the speed limits of the Australian economy," Costello told reporters.

The ruling Liberal National party faces a tough election later this year and would really rather not have the threat of another rate rise hanging over them.

Yet the government was doing its own part in stoking growth.

Public investment jumped 15.4% last quarter, adding 0.6 percentage points to GDP, with spending on defence projects alone up 64%.

All that public largesse helped make up for a subdued consumer last quarter. Household consumption rose a relatively modest 0.6%, a payback for a huge 1.4% rise in the
first quarter. It also outweighed a drag from inventories and from international trade, as imports outstripped exports.

"If anything, the economy may have already gathered too much momentum for the RBA's liking," said Brian Redican, a senior economist at Macquarie Bank. "If we get another bad inflation number in October, a hike could be on for November."

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