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Australia's Central Bank Is Still Wary on Inflation

Australia's central bank was still concerned that interest rates might not be high enough to restrain inflation when it hiked rates to a 12-year high earlier this month, minutes of the policy meeting showed on Tuesday.

Yet the Reserve Bank of Australia (RBA) board also noted tentative signs of a cooling in red-hot demand and a substantial tightening in financial conditions due to the credit crunch, suggesting to analysts it was in no rush to hike again.

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"This implies the Reserve Bank is on policy pause, but could be moved to change rates if the run of economic and market information dictates," said Stephen Roberts, research director at Lehman Brothers.

The central bank lifted its key cash rate 25 basis points to 7.25 percent at it March 4 meeting, the second hike in as many months, saying demand needed to slow substantially to restrain price pressures in a booming economy.

"We now see almost no chance of a rate change in April and any move in May would probably require very high annual inflation readings in Q1," argued Roberts. The first-quarter inflation report is due out on April 23.

Core inflation accelerated to a 16-year high of 3.6 percent last quarter, uncomfortably far above the RBA's 2 percent to 3 percent target band.

The central bank fears inflation could stay above 3 percent right out to the end of 2009, though the minutes showed it had trimmed its forecast for inflation for mid-2010 to slightly below 3 percent from 3 percent previously.

The Australian dollar dipped on Tuesday while bill futures inched higher as the minutes were not quite as hawkish as investors had feared. Some noted there was no mention of raising rates by 50 basis points, as there had been in the February policy meeting.

Disturbing

Analysts said the financial world had changed radically since the March 4 meeting. An escalating global credit crunch, emergency liquidity injections from a range of major central banks and the bailout of a U.S. investment house has severely complicated the outlook for the RBA.

"Crucially, a lot of disturbing things have happened in world markets since the meeting which suggest the RBA is on hold for the foreseeable future," said Rory Robertson, an interest rate strategist at Macquarie.

"If the global credit crisis starts taking an even bigger bite out of world growth, then ultimately the RBA may be forced to cut rates, but that's some way down the track," he added.

The shift is clear in financial markets which have discounted almost any chance of a further tightening and instead priced in no less than 38 basis points of rate cuts in the next 12 months.

The U.S. Federal Reserve meets later on Tuesday and the market now expects it to cut the funds rate by a full percentage point as it seeks to cushion the economy from a seemingly inevitable recession.

"The dovish factors are the fact that U.S. banks are going pop, that financial markets are under incredible strain, and that business and consumer confidence are down," said Matthew Johnson, a senior economist at ICAP.

"I doubt that the RBA will lift rates in May, even if inflation is ugly -- but they are a long way from giving up their tightening bias, let alone cutting rates," he added.