IMF’s inflation warning

The Reserve Bank of Australia (RBA) has been warned to raise interest rates quickly if leading indicators suggest that domestic demand will not slow as expected or the outlook for inflation deteriorates.

The warning was issued by the International Monetary Fund (IMF) in its statement ‘Australia — 2008 Article IV Consultation’.

While giving Australia’s macroeconomic policies, structural reforms and resilience to the current global financial turmoil a tick of approval, the IMF did show concern with the country’s underlying inflation, which is the highest in more than a decade, saying this presented the Government with a “significant challenge”.

It warned that further increases in energy prices and capacity constraints, particularly in the mining and housing sectors, could push the nation’s wage and consumer price index (CPI) inflation higher than originally expected.

The IMF was also less upbeat with Australia’s export markets, which could suffer as a result of the country’s high exchange rate and a slump in global demand.

Additional stress could also come from continued turmoil in international financial markets, which could result in a further tightening of credit conditions and an increase in banks’ funding costs. The IMF was also bearish in its appraisal of the country’s agricultural sector, with output unlikely to rebound from the drought as first predicted.

“A firm monetary policy stance is essential for keeping medium-term inflation expectations well anchored,” the IMF said.

“The risk that wage inflation will rise further if CPI inflation persists at current levels calls for the RBA to maintain a tight policy stance until it is clear that inflation will abate.”