Rates future over a barrel

SKY-high oil prices might yet undermine the Reserve Bank's attempts to keep the lid on inflation and force interest rates higher over the next few months.

SKY-high oil prices might yet undermine the Reserve Bank's attempts to keep the lid on inflation and force interest rates higher over the next few months.

The minutes from the Reserve Bank's June meeting, released yesterday, said that 12-year high borrowing costs of 7.25 per cent might be enough to cool demand.

Slowing retail sales, dropping employment levels, falling house prices, lower consumer and business expectations and weak business borrowings all suggest the RBA is succeeding in containing domestic inflation.

But imported inflation through higher oil prices remains the biggest unknowable and uncontrollable factor for the RBA.

On Monday night in New York, crude oil prices hit close to the $US140 level and the US dollar lost ground after a series of strong trading sessions, underlining the uncertainty and volatility dominating commodity markets and fuelling inflation across the globe.

The jump in oil prices is flowing through to higher petrol prices, which are forecast to spark a further rise in Australian inflation to above its current 16-year high of 4.2 per cent.

Crude oil prices have almost doubled in the past year. In the past month they have climbed 22 per cent -- and 10 per cent since the RBA's meeting on June 3 - to a record high of $US138.69.

The RBA said higher petrol prices could add about quarter of a percentage point to inflation over each of the June and September quarters - potentially pushing the core inflation reading close to 5 per cent.

The RBA announcement triggered a drop in the Australian dollar as markets pared back expectations of another interest rate rise.

But the market is still pricing in a 75 per cent chance of interest rates rising to 7.5 per cent by the end of the year.

In late trading the Aussie was pushed back to below US94 after inflation data in Britain hit a decade high.

But the greenback has fallen in the past two trading sessions on speculation the US Fed is in no rush to raise interest rates to support the US dollar.

Despite Saudi Arabia's pledge to boost its oil production, some market watchers said the falling chance of a Fed rate rise could push crude oil prices up to $US150 within months.

Speculators have been hedging against the weak greenback by buying long positions on oil futures, expecting the price to rise.

Economists are divided about whether the RBA's next move on interest rates will be up.

But they are united in the belief that interest rates will stay at 7.25 per cent or above for at least 12 months, after the RBA also issued a veiled warning there was "considerable uncertainty" with "strongly opposing forces operating on the economy".

The RBA highlighted that any outbreak of wage or price rises would spark a review of the bank's current on-hold policy.

"Should demand not slow as expected or should expectations of high ongoing inflation begin to affect wage and price-setting behaviour, the outlook, and stance of policy, would need to be reviewed," the RBA minutes said.

Some economists are wary the huge volatility in oil prices, which almost hit $US140 on Monday night, and the flow-on effect on petrol prices and inflation, could yet force rates up to 7.5 per cent.

ANZ head of Australian economics Tony Pearson said: "The RBA won't react to the spikes in prices but petrol prices have been high for some time and we expect to see that impacting on the June and September quarter Consumer Price Index in terms of inflation."

ANZ is forecasting the RBA will raise interest rates in August to 7.5 per cent after the release of the June quarter CPI data in late July.

However, Macquarie interest rate strategist Rory Robertson said the RBA's aggressive tightening policy, which has seen rates rise four times since August, was biting and rates would stay at 7.25 per cent for the foreseeable time.

"Importantly, the case for another hike is particularly weak at this point, because demand clearly is slowing -- and the RBA is yet to be convinced that reducing inflation this time around will require a recession, a la the early 1990s," Mr Robertson said.