Economists predict rate pause in June

RATES are now at "average levels" says RBA, and homeowners might get breathing space next month.

Home owners will pay an extra $50 a month after interest rates rose, but may get some respite next month, say economists / File

THE Reserve Bank has acknowledged its inflation forecasts were too low, prompting it to lift the cash rate by 25 basis point in May, economists say.

The increase in the cash rate to 4.5 per cent, the sixth rise in eight months, comes after the release of slightly higher than expected inflation data last week.

In its monetary policy decision the RBA said the extent of decline in inflation may not be "quite as much'' as earlier forecast.

The quarter of a percentage point rise increases repayments on an average mortgage of $300,000 by $48 a month.

Economists are now forecasting the central bank will pause in June.

In its statement the RBA said recent inflation data confirmed that it had declined from its peak in 2008, helped by a noticeable slowing in private-sector labour costs during 2009, the rise in the exchange rate and the earlier period of slower growth in demand.

Citigroup director Paul Brennan said there were two things driving the cash rate up.

"One, that they want to return to neutral given that the economy has been a lot stronger and is heading back to normal growth,'' Mr Brennan said.

"Secondly the thing that's a bit more worrying is that they have had to creep up their inflation forecasts in every quarterly statement they make, so it's quite disappointing.

"They have acknowledged that their inflation forecasts are again too low and therefore rates need to be pushed up.''

The statement also said as a result of the decision the board expects rates for most borrowers will be around average levels.

"This represents a significant adjustment from the very expansionary settings reached a year ago,'' the statement said.

"The Board will continue to assess prospects for demand and inflation, and set monetary policy as needed to achieve an average inflation rate of two to three per cent over time.''

Mr Brennan said the move back towards average levels was "consistent with the last statement''.

"That is indicative of the view that they're probably going to pause, given that they're saying there has been a big adjustment.

"That's how I'd read that.''

The interest rate rise comes a day after the central bank's index of commodity prices posted its biggest monthly increase since the measure began in July 1982.

Manufacturing, building and infrastructure sectors expanded the fastest pace since 2002.

Data released on Monday showed house prices recorded the largest annual increase since 2002.

Yesterday the Australian Bureau of Statistics house price index rose 4.8 per cent in the March quarter and 20 per cent in the year to March.