Australia central bank says rate rise risk has increased

SYDNEY - Australia's central bank said on Monday the need for tighter monetary policy has increased as strong economic demand raises the prospect of a build-up in wage and price pressures.

In its quarterly Statement on Monetary Policy, the Reserve Bank of Australia (RBA) said it expected a rise in underlying inflation to be gradual -- to around 2.5 per cent by end-2005 and 3 per cent by end-2006 -- but there was a risk this forecast could be too low.

"Given the firm demand conditions in prospect, the possibility that wage and price pressures will build more quickly cannot be ruled out," the central bank said.

"The (central bank) board decided at its February meeting to leave interest rates unchanged, while noting that the likelihood of further monetary policy tightening being required in the months ahead had increased." The RBA has left the cash rate at 5.25 per cent since the fourth quarter of 2003, when it raised rates twice to curb rising household debt that was largely associated with a prolonged housing boom.

In recent weeks financial markets have been speculating about the risk of higher interest rates in the wake of data showing unexpectedly high consumer and producer prices in the fourth quarter of 2004.

Annual inflation in the year to December was 2.6 per cent, in the top-half of the RBA's 2-3 per cent target.

The bank said while underlying inflation has been held down by the lagged effects of the appreciation of the Australian dollar during 2002 and 2003, "the maximum impact from that source has now passed".

A cooling in the housing market and credit demand during 2004 should assist prospects for sustainable economic growth.

However, it said more recently there had been signs of house prices and finance levelling out, or possibly rising.

"It is too early, however, to tell whether these latest developments represent a significant change in trend," the bank said.

"Nevertheless, the growth of credit to both the household and business sectors remains high, with aggregate credit growth still running at an annual rate of 12 per cent over the six months to December 2004."

The bank said the strong pace of economic growth during 2004 would likely continue in 2005, despite surprisingly weak economic growth of 0.3 per cent in third quarter of 2004.

Fourth-quarter gross domestic product data is due on March 2.

The bank also pointed to the importance of capacity constraints, which have been blamed for holding back minerals exports.

"With the expansion now in its 14th year, there is clearly much less spare capacity available than was the case in its early stages," it said.

"The general performance of the economy in 2004, when production was unable to keep up with the strength of global and domestic demand, is suggestive that capacity constraints may be becoming more important."

- REUTERS