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Australian Price Pressures Places Burden on Rates

Australia's inflation headache worsened in January while house prices boasted double-digit gains in 2007, figures out on Monday showed, adding to expectations for a restraining rise in interest rates this week.

The data came just a day before the Reserve Bank of Australia (RBA) holds it first policy meeting of the year and investors had already priced in a 25 basis-point rise in the cash rate to an 11-year peak of 7.0 percent. That would come on top of two hikes last year, which have done little to cool the red-hot economy.

"A further interest rate rise tomorrow is highly likely and, unless inflation pressures ease in the short-term, further hikes cannot be ruled out in 2008," said Joshua Williamson, a senior economist at TD Securities.

The central bank will announce its decision on Tuesday.

The Australian dollar firmed to near three-month highs at 90.42 U.S. cents on Monday, while bond futures were depressed by the prospect borrowing costs would rise here even as the Federal Reserve was slashing U.S. rates.

The diverging outlook for the two economies was highlighted by the strength of Australian house prices, which rose 3.2 percent in the fourth quarter of last year. For 2007 as a whole, prices were up 12.3 percent, with a couple of cities boasting gains of over 20 percent.

In contrast, the latest S&P/Case-Shiller measure of U.S. home prices showed a record 8.4 percent fall in the year to November.

"Certainly a much different picture for our housing market compared with the U.S. housing market," said Michael Blythe, chief economist at Commonwealth Bank of Australia.

Inflation Brewing

"It fits in with that idea that the current level of interest rates is not particularly restrictive and more work is required to curb inflation," added Blythe.

The extent of the task was illustrated by a private measure of inflation released on Monday which showed annual inflation ran at a 20-month high in January.

The TD Securities-Melbourne Institute monthly inflation gauge rose 3.9 percent in January from a year earlier, as households paid more for fuel, utilities, financial services and education.

That was well above the RBA's 2 to 3 percent target band and follows the official reading on underlying inflation which ran at a 16-year high of 3.5 percent in the year to December.

"The high results show that inflation remains problematic and that the RBA will need to tighten monetary policy further," said Williamson at TD.

Other figures out on Monday showed Australia's trade deficit narrowed as expected to A$1.94 billion ($1.8 billion) in December, from A$2.16 billion in November.

Imports were flat in the month, though still near record levels as the strength of domestic demand keeps sucking in everything from cars to computers to capital equipment. Indeed, imports outstripped exports for the fourth quarter as a whole, suggesting trade had subtracted from gross domestic product (GDP) in an otherwise strong quarter.

Still, exports did rise 1.3 percent in December and hopes remain high for an improved performance this year. "The prospect over the course of this year is for some pretty substantial volume increases in exports as some of the capital investment in the mining sector comes on-stream," said Stephen Halmarick, co-head of market economics at Citi.