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Australia Economy Surprisingly Resilient in Q1

Australia's economy grew by more than expected last quarter, helped by spending on infrastructure and defence, while the consumer held up surprisingly well in the face of high interest rates and surging living costs.

The unexpected resilience suggested the Reserve Bank of Australia (RBA) might yet have to tighten further to truly cool demand, sending the Australian dollar higher and bonds down.

Gross domestic product (GDP), or the value of all goods and services produced in the economy, rose 0.6 percent in the first quarter from the fourth, when it grew 0.7 percent.

That was double the market forecast and a big surprise to many as the monthly data had been painting a much weaker picture. Growth for the year also slowed only moderately to a still robust 3.6 percent, well above the 2.8 percent pace expected.

"While private demand has slowed, the overall economy is proving more resilient than many assumed," said Su-Lin Ong, a senior economist at RBC Capital Markets.

"This will only reinforce the RBA's tightening bias," she added. "If rates are going anywhere this year, it's up."

The central bank has raised interest rates four times since August in an attempt to cool booming domestic demand and restrain inflation, which accelerated to a 17-year high last quarter.

The RBA left rates unchanged at its monthly policy meeting on Tuesday but warned that it was ready to act again if the economy did not slow as desired.

"There is little in today's release that suggests we can relax about the inflation or interest rates outlook just yet," said Scott Haslem, chief economist at UBS.

"Over time, though, further demand moderation is likely and inflation pressures should ease, keeping the RBA on hold this year," he argued.

The market was not so sure with rate futures quickly shifting to price in 25 basis points of tightening for the coming 12 months, compared to just 12 basis points on Tuesday.

Trade Boost Still to Come

Overall, Australia's GDP amounted to an inflation-adjusted A$260.6 billion ($248 billion) in the first quarter of 2008 and A$1.03 trillion for the 12 months to March, or A$48,856 for every man, woman and child in the country.

Household consumption was the single biggest contributor to growth, adding 0.4 percentage points, though that was less than half of the contribution made in the previous quarter.

One surprise was government spending, where a 135 percent rise in defence investment helped add 0.3 percentage points to GDP growth. Private spending on infrastructure like roads and ports added a similar amount.

The largest drag was the trade account, as bad weather hampered exports in the quarter while imports kept climbing. In all, net exports took 0.7 percentage points from growth.

Still, the trade outlook has brightened considerably as voracious demand for Australia's resource exports from China and India has sent commodity prices spiralling higher, delivering a windfall to profits, wages, dividends and tax receipts.

Australia's terms of trade -- the ratio of export prices to import prices -- has already surged by 40 percent in the past few years. Analysts expect a further 20 percent rise this year alone thanks to eye-popping increases of 70 to 200 percent for coal and iron ore, the country's two biggest exports.

That good fortune is a headache for policy makers, however, as it could rekindle consumption at a time when inflation is running well above the RBA's 2 to 3 percent comfort zone.

"The enormous terms of trade boost is still to come and that's going to support the economy in the second half of the year," said Michael Workman, a senior economist at Commonwealth Bank. "We doubt it's going to slow as much as the RBA wants."