The Reserve Bank of Australia raised its inflation forecasts and said the economy's expansion shows considerable momentum, reinforcing speculation the bank will increase interest rates by March.

Core inflation will accelerate to 3.25 percent by December and remain there until June, more than a previous estimate of 3 percent and exceeding its target, the central bank said in a quarterly statement in Sydney Monday. The bank trimmed its economic growth forecast to 3.75 percent for the year ending June 30, from 4.25 percent, because drought has slashed farm output.
The higher inflation forecast comes less than two weeks before a general election in Australia and follows the bank's decision to raise the benchmark interest rate to an 11-year high last week. That increase prompted Prime Minister John Howard, to apologize to voters, whom he acknowledged would be angered by the rise.
“There is a long fight ahead against inflation and that means there is only one direction for interest rates,” said Brian Redican, senior economist at Macquarie Bank Ltd. “They will raise rates in February.” Stevens aims to keep inflation between 2 percent and 3 percent on average.
Core inflation, which excludes the most volatile items in the consumer price index, was about 3 percent in the year ended Sept. 30.
‘Global uncertainty’
The central bank noted that sentiment in global financial markets remains fragile, suggesting policy makers may leave the benchmark rate unchanged at the next meeting in December as they monitor the outlook for world growth.
“There's an acknowledgement in today's statement of global uncertainty and the credit situation,” said Su-Lin Ong, senior economist at RBC Capital Markets in Sydney. “It suggests the Reserve Bank isn't planning to lift rates in the near term.”
Australia's currency and bond yields fell as stock markets in the Asia-Pacific region slumped on renewed concerns losses in credit markets will curb the global economic expansion.
“The Australian dollar is primarily adjusting lower because near-term sentiment has weakened due to fragile and volatile equity markets,” said Richard Grace, chief currency strategist at Commonwealth Bank of Australia in Sydney. The RBA's statement isn't bearish for the currency.
The nation's dollar traded at 89.44 U.S. cents at 04:35 P.M. in Sydney from 90.68 cents before the statement was released and 91.15 cents late in New York on Nov. 9. The yield on the government bond maturing March 2019 fell 3 basis points to 5.92 percent. The S&P/ASX 200 stock index dropped 1.4 percent.
Credit-market fallout
“Reflecting the sensitivity to risk, the local currency has tended to move in line with equity markets,” the central bank said today. Still, the fallout in Australia from the credit crunch has been “relatively contained.”
Governor Glenn Stevens raised the overnight cash rate target by a quarter percentage point to 6.75 percent on Nov. 7, following a similar move in August. Nineteen of 24 economists surveyed by Bloomberg News last week forecast another increase by March.
Last week's move was the sixth rate increase since Howard, 68, won the 2004 election with a promise to keep interest rates at ``record lows,'' and may negate his claim to be a better economic manager than opposition Labor Party leader Kevin Rudd, 50.
Australia's election will be held on Nov. 24. Labor holds a 10-point lead in voter support over the coalition, according to a Newspoll published today. The poll had a margin of error of plus or minus 2.5 percentage points.
The central bank said that higher borrowing costs, the nation's strong currency and slowing global growth may cool inflation to 3 percent by December 2008.
“But it is also possible at this stage of a long economic expansion that inflation will be more difficult to contain, particularly if domestic demand does not moderate,” it said.
Overseas investors have driven the currency up 14 percent this year, lured by Australia's benchmark interest rate, which is 2.25 percentage points higher than the key U.S. rate. The Australian dollar reached 94 U.S. cents, the strongest in more than 23 years, after last week's interest-rate adjustment.
The economy has been growing at the fastest annual pace in three years, pushing the jobless rate to the lowest in three decades and stretching resources at a time when oil and food prices are surging globally.
The central bank also noted that conditions in the farming industry have deteriorated over recent months'' because of the worst drought on record.
It kept its forecast for growth in the non-farm economy unchanged at 3.5 percent for the 12 months ending June 30, 2008, and the following year.
Australia marked its longest run of jobs growth in more than 12 years in October as miners and retailers hired more workers.
“Consistent with the strong labor-market conditions, the pace of growth in wages has been firm,” the central bank said.
The wage price index probably rose 4.2 percent in the third quarter from a year earlier, equaling the strongest annual increase since the series began in 1997, according to a survey of economists. The report will be released on Nov. 14.
(Source: Bloomberg)