Australia Inflation Pressure to Prompt Rate Rise

Annual inflation in Australia accelerated to a six-year high in February, according to a private measure of prices, adding to expectations interest rates will rise this week to cool a booming economy.


The Reserve Bank of Australia (RBA) holds its monthly board meeting on Tuesday and is seen almost certain to lift interest rates by 25 basis points to 7.25 percent, the highest since July 1996.

"Another rate hike from the RBA tomorrow is in the bag," said Besa Deda, senior market strategist at St. George Bank. "The accompanying statement is still likely to maintain a hawkish tone, suggesting further rate hikes cannot be ruled out in an environment where domestic demand remains robust and inflationary pressures are elevated," added Deda.

Those pressure were evident in the TD Securities-Melbourne Institute monthly inflation gauge, which rose 0.3 percent in February as households paid more for rents, vegetables and financial services.

Annual inflation picked up to 4.0 percent, from 3.9 percent in January, well above the top of the RBA's 2 to 3 percent target band.

"The gauge continues to show inflation on a strong upward trend," said Joshua Williamson, a senior strategist at TD. "For inflation to move lower and eventually fall within the RBA's target band, further monetary policy tightening is required."

That would follow a similar sized rise in February and would be the first back-to-back rate rise since late 2003.

"Unless inflation pressures ease in the very near term, further rate rises beyond this are likely," said Williamson.

The Melbourne Institute's Don Harding said that, based on the February report, the government measure of consumer prices (CPI) could rise a hefty 1.28 percent in the first quarter.

That would lift the annual rate of CPI inflation to 4.2 percent, from 3.0 percent in the fourth quarter. The CPI report for the first quarter is due on April 23.

What Tightening?

Harding noted that if inflation proved to be 4.2 percent as expected it would mean that real interest rates, adjusted for inflation, had not risen even after the RBA's hikes.

"The real interest rate is 2.8 percent, the same as almost five years ago," said Harding. "Inflation is unlikely to be brought under control without increasing the real interest rate above 3.5 percent for a sustained period of time."

With inflation around 4.0 percent, that would imply the RBA needed a cash rate of at least 7.5 percent.

A Reuters poll of 23 analysts last week found 19 expected to rates to reach at least 7.5 percent, probably in May.

Investors, however, are less sure another hike will be needed given the latest slide in world equities, worries over a U.S. recession and a steep rise in bank funding costs stemming from the global credit crunch.

The S&P/ASX 200 Index shed over 3 percent on Monday, leaving it down 15 percent for the year so far, while three-month bank bill rates hit 8 percent having surged 60 basis points in little more than a month.

Yet government data on gross company profits out on Monday showed healthy growth of 3.9 percent in the fourth quarter of 2007, and nearly 12 percent for the year as a whole.

The construction, property, wholesale and manufacturing sectors all reported big gains, while mining only managed a modest increase as rising costs ate into margins.

Firms also added to inventories in the quarter, though the 0.7 percent increase was smaller than in the third quarter as sales topped expectations. That implied stocks shaved about 0.2 percentage points from economic growth last quarter.

The main report on gross domestic product (GDP) is due on Wednesday and most analysts are still looking for solid growth of around 0.8 percent in the quarter, and 3.9 percent for the year.

Indeed, domestic demand will be even stronger, as external trade likely dragged on growth in the quarter.