(May 5, 2010)

THE Reserve Bank has acknowledged its inflation forecasts were too low, prompting it to lift the cash rate by 25 basis point in May, economists say.

The increase in the cash rate to 4.5 per cent, the sixth rise in eight months, comes after the release of slightly higher than expected inflation data last week.

In its monetary policy decision the RBA said the extent of decline in inflation may not be "quite as much'' as earlier forecast. The quarter of a percentage point rise increases repayments on an average mortgage of $300,000 by $48 a month. Economists are now forecasting the central bank will pause in June.

In its statement the RBA said recent inflation data confirmed that it had declined from its peak in 2008, helped by a noticeable slowing in private-sector labour costs during 2009, the rise in the exchange rate and the earlier period of slower growth in demand.

Citigroup director Paul Brennan said there were two things driving the cash rate up. "One, that they want to return to neutral given that the economy has been a lot stronger and is heading back to normal growth,'' Mr Brennan said. "Secondly the thing that's a bit more worrying is that they have had to creep up their inflation forecasts in every quarterly statement they make, so it's quite disappointing.''"They have acknowledged that their inflation forecasts are again too low and therefore rates need to be pushed up.''

The statement also said as a result of the decision the board expects rates for most borrowers will be around average levels. "This represents a significant adjustment from the very expansionary settings reached a year ago,'' the statement said. "The Board will continue to assess prospects for demand and inflation, and set monetary policy as needed to achieve an average inflation rate of two to three per cent over time.''

(Source from:theage.com.au)