US crisis may stall CPI-linked rate rise

27 Jul 2011, 5:07 pm   -   Source: AAP

The Reserve Bank is likely to be uncomfortable about the latest CPI result but the US debt crisis will likely stop an interest rate rise for now.

The potential global fallout from the US debt crisis may stop the Reserve Bank of Australia (RBA) from raising interest rates for now.

But economists say the latest Australian inflation figures suggest the central bank will be far from happy.

The RBA holds its monthly board meeting on Tuesday, the same day as the world's richest economy could default on its debt for the first time in its history if US politicians cannot strike a deal by then.

The June quarter consumer price index (CPI) released on Wednesday showed the annual rate of inflation at 3.6 per cent, well above the RBA's two to three per cent target band, and its highest level since late 2008.

The more crucial underlying measures of inflation, in terms of interest rate policy, also showed an acceleration in price pressures.

Treasurer Wayne Swan blamed a 27 per cent spike in fruit prices in the wake of last summer's natural disasters in Queensland for the stronger than expected CPI outcome, making up 0.4 per cent of the overall 0.9 per cent quarterly inflation increase.

"This has been tough on family budgets, but we do know that prices should come down as crops regrow and as farm production comes on," he told reporters in Sydney.

Higher global oil prices also had an inflationary impact.

He said there were "swings and roundabouts causing a temporary softness in the economy", such as a high Australian dollar, cautious consumers and by uncertainty over the debt problems in Europe and the US.

"Despite all of this, the fundamentals of our economy remain strong and the medium-term outlook is strong," he said.

But opposition treasury spokesman Joe Hockey believed inflation was increasingly getting "out of control", and this may well lead to higher interest rates.

He said the "Queensland factor" was just an excuse.

"I don't think it is just bananas, I think it covers a whole range of different products," Mr Hockey told reporters in Sydney.

"Next quarter I fully expect Wayne Swan to claim that the dog ate his homework."

The 0.9 per cent CPI rise in the June quarter was larger than the 0.8 per cent predicted by economists, and came on top of the 1.6 per cent spike in the March quarter.

Underlying inflation measures, which smooth out volatile price swings, also rose 0.9 per cent in the quarter and similar to the previous three months, lifting the annual rate to 2.7 per cent from 2.25 per cent.

The growing risk of an interest rate rise saw the Australian dollar jump to above 110 US cents, its highest level since it was floated in December 1983.

Other financial markets were also less confident that the ongoing global uncertainties would cause a Australian interest rate cut.

Interest rate futures - that predict the likely course of the official cash rate - are now predicting only a one-in-four chance of a cut by the end of the year, having been more or less pricing in a 25 basis point reduction before the inflation data was released.

Commonwealth Bank of Australia chief economist Michael Blythe said in normal times such inflation outcomes would probably have been enough to produce some near-term policy action from the RBA.

"But these are not normal times," Mr Blythe said.

"The RBA's prudent approach is likely to continue for a while. But the case for higher interest rates over time is still there. And there is now a risk of an earlier move than our November call."

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