Rate rises depend on oil price: RBA

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Interest rates are likely to remain on hold unless the price of oil rises again, the Reserve Bank says.

In its last statement on monetary policy for the year, the bank said the Australian economy was generally in sound condition with no signs yet of a breakout of inflation.

But it warned that if oil prices started to rise again, then this could cause a round of inflation that may force the bank into lifting interest rates.

Rates have been on hold since the bank lifted them to 5.50 per cent in March.

The latest inflation figure was three per cent - at the top of the Reserve Bank's target range - but underlying inflation, which removes fluctuations caused by such things as oil and food, was much lower.

The bank said headline and underlying inflation was likely to reach the three per cent mark in the medium term, but with the economy growing at a sustainable level.

``Given the shift in the growth of demand to a more sustainable pace and the prospect of a mild easing in labour market conditions, the rise in inflation is expected to be relatively modest, with underlying inflation levelling out at around three per cent in the second half of 2006,'' it said.

``Assuming no further increase in international oil prices, this would mean headline CPI inflation remaining close to three per cent over that period.

``Of course, if oil prices instead were to continue rising, CPI inflation would be higher and, should such a situation persist, it would increase the likelihood of significant second-round price effects and increases in inflation expectations.''

The bank said although inflation might rise to the top end of the three per cent target, this did not necessary mean the bank would have to act through higher rates.

``While underlying inflation was forecast to rise modestly over the year ahead, inflationary trends overall were expected to remain consistent with the target over the medium term,'' it said.

``The fact that the headline CPI figure has moved to the top of the range that the bank seeks to achieve on average does not of itself call for a monetary policy response, but needs to be placed in the context of the medium-term monetary policy framework.''

Globally, the bank said the spike in oil prices has yet to have major repercussions, especially in terms of inflation.

``As yet, there has been little evidence of any significant second-round inflationary effects, and at this stage core inflation rates in most advanced countries remain contained,'' it said.

The bank said the deflationary impact of the stronger Australian dollar had now worked through the economy, with the prices of tradeable products drifting up.

The tight employment sector had meant there was a pick-up in wages.
It said global economic conditions remained in Australia's favour, with the prices for Australian commodity exports remaining good.

``The economic situation reviewed by the board at its recent meetings has been one in which international conditions appeared likely to remain favourable to growth in Australia, while the domestic economy was continuing to operate at a relatively high level of capacity utilisation,'' it said.

``Growth in demand and output remained solid, but had eased back from the peaks seen in recent years.''

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