90pc chance of interest rate rise by end of year

MARKETS have almost fully priced in another interest rate rise to 7.5 per cent within five months.

MARKETS have almost fully priced in another interest rate rise to 7.5 per cent within five months.

Rising inflationary pressures driven by higher food and oil prices are being blamed for again unsettling investors.

The spectre of another interest rate rise yesterday sent the stock markets into reverse and pushed the Australian dollar ever closer to parity with the greenback.

Investors on the Sydney Futures Exchange now rank the possibility of a rate rise by late this year as close to a 90 per cent chance.

Traders had been betting on a rate cut but last week the odds swung sharply after the Reserve Bank of Australia board minutes for May showed it thought long and hard before a rise was rejected.

Economists said the first signs of another lift in consumer spending and the RBA will be forced to head-off inflation with a 25 basis point interest rate rise to 7.5 per cent.

The uncertainty flowing from the United States, which is in the grip of a recession, sent the S&P/ASX 200 index down 1 per cent to 5707 points.

Asian markets were also down heavily yesterday after Wall Street last week had its biggest weekly fall in almost four months on speculation that higher prices will depress consumer spending and the financial sector faces more losses from the housing slump.

Market watchers expect the Australian index could drop 5 per cent over the next few months - a traditionally flat period in the markets.

Colonial First State head of investment markets research Hans Kunnen said it would be a "bumpy ride" over the next six months.

"There are concerns about more sub-prime problems in the US and weaker house prices will flow through to the corporate sector," he said.

Mr Kunnen said the markets' rally from its lows of 5039 points in mid-March had been overdone and a correction might have begun.

But he admits signs of stronger consumer spending is a double-edged sword as it could send interest rates higher but also boost investor confidence in the major retail stocks.