Bank sends clear signal on rates

Australia's central bank warned yesterday that interest rates could rise within months to offset the risk of higher inflation, prompting the biggest fall in 90-day bank bill futures in more than a year.

The need for tighter monetary policy has increased as strong economic demand raises the prospect of a buildup in wage and price pressures, the Reserve Bank of Australia said in a quarterly Statement on Monetary Policy.

While the central bank expected a gradual rise in inflation to the top end of its 2 per cent to 3 per cent target by the end of next year, there is a risk this forecast could be too low.

"It looks like all systems go for a rate rise. This is probably as clear cut as central banks ever get. We've got a rate rise factored in for May, but the risk now is certainly that it happens before that," said Michael Blythe, chief economist at Commonwealth Bank of Australia.

Rate-sensitive bank bill futures for the June quarter fell 14 basis points, pushing up the implied yield to 5.74 per cent, well above the 5.25 per cent cash rate.

The Australian dollar rallied about a half cent to above 77USc to reflect the interest rate expectations.

The central bank has kept the cash rate at 5.25 per cent since the fourth quarter of 2003, when it increased rates twice to curb rising household debt that was associated with a prolonged housing boom.

Expectations for another rate rise were strong through most of 2004 before fading towards the end of the year as figures indicated the economy had calmed.

But financial markets started to factor in the risk of higher interest rates again in recent weeks after 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.

The Reserve Bank said that while underlying inflation had been held down by 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 support the prospects for sustainable economic growth.

But the central bank said more recently there had been signs house prices and housing finance were levelling out, or possibly rising.

It was too early to tell if this marked a significant change in trend, but in any case the growth of credit to both the household and business sectors remained high.

The bank cited the rapid fall in the unemployment rate to a 28-year low of 5.1 per cent in December, consumer confidence at near record highs and business surveys reporting strong conditions throughout 2004.

- REUTERS