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Australia Trade Less of a Drag as Economy Climbs

Australia's trade deficit was less of a drag on the economy than first thought last quarter, adding to a raft of evidence that growth was picking up sharply and underlining the risk of higher interest rates in the longer run.

While the country's current account deficit was higher than expected at A$15.38 billion (US$12.8 billion) in the first quarter, the shortfall on trade narrowed as commodity exports improved.

As a result, the trade deficit likely only shaved 0.2 percentage points from gross domestic product (GDP) last quarter.

That was a lot less than the huge 1.3 percentage points trade carved out of growth in the fourth quarter and left analysts in a state of excitement about the economy.

"What's important is how broad-based growth is becoming," said Brian Redican, a senior economist at Macquarie Bank. "The economy is starting to fire on all cylinders, which makes it less vulnerable to a downturn." "That also means the risks for interest rates are on the upside, though no move is likely for the next few months."

Financial markets hardly budged on the data as it did nothing to change expectations that the Reserve Bank of Australia (RBA) would keep its cash rate at 6.25% after its monthly policy meeting on Tuesday.

Still, the acceleration in economic activity did suggest the risk was for higher interest rates in the long run, and bill futures imply a hike later this year or early next.

The GDP report is due on Wednesday and economists have been steadily revising up forecasts for growth to reflect strength in business investment, inventories, sales and profits.

Many now think the economy expanded 1.1% to 1.3% last quarter, a step-up from an already brisk 1.0% in the fourth quarter of 2006.

And that comes despite the drag on the farm sector from one of the country's worst ever droughts.

A Faster Beat

There was also every sign the upturn continued into this quarter, with almost all the recent monthly data upbeat.

The latest figures on approvals to build new homes showed a hefty 8.1% increase in April, far above the 2.5% gain expected by analysts.

Even the lackluster private house sector showed signs of life with a 3.3% rise. "Going forward, approvals suggest dwelling construction looks more decisively to be adding to GDP growth from here on, and it's not surprising given flat rental vacancy rates and that rents are starting to rise," said David de Garis, a senior economist at nabCapital. "It adds to the strong activity
picture."

Other figures showed a marked pickup in activity in the services sector, which accounts for two thirds of the economy.

The Australian Industry Group-Commonwealth Bank Performance of Services Index rose 3.3 points points to 56.1 in May, well above the 50 threshold that separates expansion from contraction. Both new orders and sales hit three-year highs.

"The ongoing, broad-based lift in services sector readings is consistent with other recent data, such as retail sales, business credit, employment and various business surveys, sign-posting the fact that the non-farm economy has picked up speed," said John Peters, a senior economist at CBA.