Inflation upgrade lifts rate rise chance

The chance of a further interest rate rise in the year ahead has increased dramatically after the Reserve Bank of Australia lifted its inflation forecasts in a statement released today.

In its quarterly statement, the RBA says inflation is likely to increase in the short term and will not start falling unless there is a significant fall in the level of domestic demand.

“The risk of inflation remaining uncomfortably high for some time is considerable. Absent a further shift in economic risks to the downside, therefore, monetary policy is likely to need to be tighter in the period ahead,” the RBA says.

The RBA had previously forecast that inflation would fall to between 2.75% and 3% after 2008, but it now believes that inflation will still be around 3% – the upper limit of its inflation target band – until the end of 2009.

The RBA’s stark comments have already created ripples in the markets, with Westpac chief economist Bill Evans saying he is shocked with the extremity of the RBA’s statement on inflation.

Westpac now believes the RBA will lift rates again at its next meeting in March, less than three weeks away.

The only possible reprieve from higher rates could come if global growth slows dramatically because of the international credit crisis. But while there is significant uncertainty about the global outlook, the RBA says both domestic demand and Australia’s key markets in China and India have so far shown little sign of faltering because of the crisis.

Rents, a significant component of inflation measures, look set to rise after new housing finance dropped 0.6% in December, signalling continued tightness in Australia’s housing market.

Significantly, interest rate rises appear to have affected investors most heavily, with approvals for owner-occupied housing increased 0.5% against a fall in investor loans of 3%.

And wages pressures appear likely to mount, with ANZ job ads data for January showing the number of jobs advertised increased 1.8% – 31.9% up on this time last year.

On the markets, at 12.40pm the S&P/SX 200 is down 2.2% on Friday’s close to 5530.8, thanks primarily to a weak lead from US sharemarkets on Friday.