Australia: Rate rise likely as inflation soars--Inflation outlook at 20 year high--9.7%

THE ECONOMY is showing few signs of restraint and the outlook for inflation has reached a 20-year high, according to an economic study released yesterday.

The Westpac/Melbourne Institute analysis of future and present activity for July has again revealed the underlying strength of the economy and adds to the case for a further interest rate rise.

While the results are heavily distorted by the introduction of the GST, Westpac general manager of economics Bill Evans said rising import prices, higher fuel costs and a tight labour market are making a significant contribution to the inflation outlook.

"The current strong Australian economy coupled with rising inflationary pressures support Westpac's view that the Reserve Bank will raise interest rates by 0.25 per cent on October 4 prior to a further rate increase later in the year," he said.

The study's leading index, a combination of indicators which show the likely direction of the economy over the next six to nine months, suggests growth may fall as low as 1.9 per cent next year. But Mr Evans said the result was heavily affected by the fall away in housing after the pre-GST rush and the long-term growth trend remained a healthy 3.7 per cent.

The co-incident index, measuring present activity, showed growth reaching as high as 6 per cent in July, with a long-term trend of 4.8 per cent.

The leading indicator for inflation has reached a 20-year high of 9.7 per cent, up from 8.6 per cent in June. While the result is affected by the GST  which the Reserve Bank discounts as a one-off impact when assessing the inflation numbers  other surveys show price pressures are growing throughout the production chain.

"To some extent this situation may overstate the risk of higher inflation in that the recent tax changes have distorted the situation," the study says.

"However other influences are looking less optimistic."

Dresdner Kleinwort Benson chief economist Rob Henderson said yesterday the rising oil price was clouding the outlook for the economy for the Reserve Bank.

"The big risk from an oil shock is not inflation but recession," he said.

Mr Henderson said central banks could do little to counteract the effect of a rise in fuel prices other than to persuade the market it was a one-off.

If oil prices stayed high, however, it would eat into consumers' disposable incomes, while company profits would drop as users of oil tried to absorb higher fuel costs. Uncertainty and falling profits would stifle private investment.

"In our view, the uncertainty about the outlook for world growth and asset prices, as a global oil shock looms on the horizon, is reason for the Bank to act with caution at the October Board meeting.

"Caution suggests the Bank will not simply focus mechanically on their 12-month inflation forecast, which will be higher due to oil and the AUD, put on their blinkers, and tighten monetary policy.

"Oil is a good reason for RBA to do nothing for now.''

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-- Carl Jenkins (Somewherepress@aol.com), September 21, 2000