RBA too slow to act on inflation

THE Reserve Bank has been criticised for not taking earlier action on interest rates to avoid the spike in inflation.

RBA too slow to act on inflation

THE Reserve Bank has been criticised for not taking earlier action on interest rates to avoid the spike in inflation.

Economists said the central bank was preparing to raise rates in May last year but was hit with nerves after one inflation figure was not as strong as expected.

Inflation has now risen sharply and home owners have been warned that more rate rises are on the way after the RBA declared the economy needed to slow dramatically to curb price rises.

The Reserve is set to increase its inflation forecasts on Monday, after economists said estimates were too conservative.

Macquarie senior economist Brian Redican said core inflation, now at an annual rate of 3.6 per cent, would have been lower if more action had been taken last year.

The RBA raised rates in August and November last year. The financial markets were surprised a hike was not ordered in May, after a speech in March from assistant governor Malcolm Edey advocated an increase.

"There was a couple of times in 2007 the RBA was about to pull the trigger but there were financial market disturbances and there were signs core inflation was restrained," Mr Redican said.

"But the RBA did not push the button. Had they had the cannon fully loaded in 2007, I think they would be better placed to combat inflation now.

"The RBA had primed the market for a rate rise but they were surprised by a low (March quarter) inflation reading."

A May rate rise would have put the RBA on a collision course with the Howard government's budget, but it had ordered a hike in May 2006.

Westpac chief economist Bill Evans said there was a strong case for the RBA to have taken greater policy action last year aimed at bringing inflation down.

"They probably regret that themselves," Mr Evans said of the decision not to raise rates in April and May last year.

ANZ chief economist Saul Eslake said the RBA had the delicate task last year of managing rates while stimulus was being added to the economy by the government.

"I would say, and I'm not critical of the RBA, that it's been left to deal with inflation on its own," Mr Eslake said.

"At the most charitable, I would say fiscal policy has done nothing to help, but I do think it has contributed at the margin to the problem."

Most economists forecast underlying inflation could creep higher to an annual rate of 4 per cent by the end of year, which would mean higher interest rates.

The Rudd Government's plan to target a budget surplus of 1.5per cent of GDP has been criticised by economists as not ambitious enough to bring down inflation.

Investors have started to speculate whether the RBA could order a back-to-back hike in March to take interest rates to 7.25 per cent.

The odds from the futures market are tipping a 20 per cent chance of a March hike, but a near 50 per cent likelihood of another increase by the middle of the year.

On the Australian stock market, shares in most major banks fell as investors bet they would face higher funding costs.

The Australian dollar dipped slightly but recovered to US90.76c as analysts highlighted that interest rates in Australia and US are at the greatest difference for 3 1/2 years.