Australia's economy grew at its fastest pace in over three years last quarter as consumers spent freely and business investment surged, boding well for further growth in coming quarters.
The surprising strength lifted the Australian dollar to 17-year highs as investors priced in a greater risk that higher interest rates might eventually be needed to restrain such boisterous growth.
"It's fantastic. You have strong growth and low inflation. It really doesn't get any better than this," enthused Adam Carr, a senior economist at UBS.
"We don't see this GDP release as a smoking gun for a near-term rate hike but we certainly think that if this pace is sustained over the rest of this year, we are looking at rate hikes in 2008," he added.
Australia's gross domestic product (GDP) rose 1.6% in the three months to end-March, easily beating forecasts of a 1.2% increase. Annual growth quickened to 3.8% from 2.9% in the previous quarter.
The inflation-adjusted value of all goods and services in the quarter climbed to A$240.29 billion (US$200 billion), setting the economy on course for its first trillion-dollar year.
Household spending added a hefty 0.9 percentage point to growth, with consumers emboldened by robust wage growth and an unemployment rate at a 32-year low.
Business investment contributed a huge 1.2 percentage points to growth. This was boosted in part by the shift of telecom giant Telstra to the private sector, but, even accounting for that, spending was high.
In a further sign of confidence, companies stocked up on inventories to meet rising demand and that added another 0.6 percentage point to output in the quarter.
Too Fast?
The only drags were from trade, as imports grew faster than exports, and the farm sector, where drought still lingered.
"With the rural sector likely to revive in the second half of the year and stimulus from tax cuts coming, the economy could well maintain this momentum," said Brian Redican, a senior economist at Macquarie Bank.
"But while the economy is healthy now and inflation contained, growth is starting to run above potential and that means inflation risks in the longer run," he added.
Underlying inflation slowed to an annual 2.7% in the first quarter, within the central bank's 2-to-3% target range.
Last month, the Reserve Bank of Australia (RBA) warned that inflation was likely to accelerate anew next year, given the strength of demand and a general lack of spare capacity after 16 years of economic growth.
Thus, even though the central bank left rates at 6.25% on Wednesday after its monthly policy meeting the day before, financial markets are pricing in an increase to 6.5% either late this year or early next.
"The likelihood that headline and core inflation will rise back up into the top half of the RBA's target range in 2008 means the RBA is likely to move off the policy sidelines early next year," said Stephen Walters, chief economist at JPMorgan.
But not everyone saw economic success as a threat. "Somebody's sure to get all hot and bothered about rapid growth," said Tony Meer, chief economist at Deutsche Bank.
"But the fact is that, for the first time in a long while, we're seeing output rise faster than demand and that means it's non-inflationary growth. So, what's not to like?"