Rate rise 'on the cards'

ONE of the country's biggest banks still believes an August interest rate increase is on the cards, despite signs of a slowing economy and an unexpected drop in employment.

Rate rise 'on the cards'

ONE of the country's biggest banks still believes an August interest rate increase is on the cards, despite signs of a slowing economy and an unexpected drop in employment.

ANZ Bank's co-head of Australian economics and interest rate research Warren Hogan is forecasting another huge jump - 1.3 per cent - in the underlying measure of inflation for the June quarter.

The ANZ warned last month of the risk of possible interest rate rises in both August and November.

"The only thing stopping an August rate hike would be a much sharper decline in domestic growth indicators, or some event which reinforces a weaker growth outlook," Mr Hogan said.

"We don't think one soft employment report is enough."

Employment fell by 19,700 in May data, released last week, the first drop in nearly two years, prompting financial markets to wind back expectations of another interest rate rise this year.

But Mr Hogan argues the labour force numbers are notoriously volatile, and while forward indicators suggest a slowing in employment growth, they do not suggest a collapse.

"If we get another large decline in employment next month we may re-evaluate the outlook for employment, but at this stage our analysis tells us that employment will not slow enough to short-circuit any leakage of rising inflation expectations into wages."

The official inflation report is due on July 23, just two weeks before the Reserve Bank's August board meeting.

ANZ's predictions come despite this week's release of the minutes from RBA's June board meeting, which were viewed as taking a softer tone on the interest rate outlook with a caveat about not tolerating excessive wage demands prompted by rising inflation expectations.

Mr Hogan says the minutes should be ignored given the last board meeting on June 3 came the day before a much stronger-than-expected set of national accounts for the March quarter.

Last week's speech by RBA Governor Glenn Stevens contained a more "hawkish" tone, he said.

In contrast, a senior Westpac economist yesterday said that underlying inflation for the June quarter could show signs of slowing.

Annual underlying inflation struck a fresh 16-year high of 4.25 per cent in the March quarter, well above the Reserve Bank of Australia's (RBA) 2-3 per cent target band.

The central bank is forecasting underlying inflation remaining at 4.25 per cent in the June quarter before gradually easing to below 3 per cent by the end of 2010.

"Our view is that the next CPI release will hopefully demonstrate some slowing in the quarterly pace of underlying inflation," Westpac senior economist Anthony Thompson said.

The significant increase in interest rates since August will continue to weigh on domestic demand and will help return inflation to the target band in late 2010, he said.

The RBA last raised its official cash rate in March.