Despite the Greek debt crisis roiling international financial markets, Australia’s rising inflationary pressures keeps the possibility of a May Reserve Bank rate increase a strong possibility.

Consumer prices in the first quarter of 2010 rose 0.9%, above economists’ forecasts of 0.6% to 0.8%. In the year, prices rose 2.9%, at the upper edge of the RBA’s preferred target band of 2–3%, increasing the chances the central bank will raise the overnight cash rate next week for the third time this year.

On the other side of the equation is the escalating Greek debt crisis. Standard and Poor’s, the international credit rating agency, lowered their assessment of Greece’s, Portugal’s, and Spain’s sovereign debt, dropping Greece to junk status. The action caused a slump in global financial markets, with the ASX falling 1.2%.

Hardest hit were the mining sector. BHP Billiton dropped 2.2%, Rio Tinto 2.6%, both dragging down the market.

Stephen Walters, chief economist with JP Morgan, told a Business Daily reporter the next few days would be crucial for resolving the European crisis and the International Monetary Fund would likely be involved. How the situation would weigh on the Reserve Bank’s interest rate decision would become clearer at that time.

“The Greek issue may settle down if the IMF comes in,” he said, “or it may continue to erupt. If that’s the case then it’s still a very close call next week.”

Guy Debelle, assistant governor with the RBA, noted that to date, Australia had not been tainted by the Greek debt crisis. But if financial market conditions collapse as they did in late 2008, that could change.

Nevertheless, the odds of another 25 basis point increase is roughly 33%. That would put the cash rate at 4.5%.

The release from the Australian Bureau of Statistics showed that core inflation, which strips out volatile items such as fuel and food items, rose 0.8% in the quarter and 3.05% in the year, taking it above the RBA’s target band.

But the strongest inflationary pressures were in fuel, vegetables, pharmaceuticals, and electricity, reducing the accuracy of the RBA’s forecast for inflation to ease to 2.5% in the second quarter. That forecast was made as recently as February.

Source: http://www.heraldsun.com.au/business/cpi-heat-on-rates/story-e6frfh4f-1225859647557