Following
a decision taken by the Board at its meeting yesterday, the Bank will
be operating in the money market this morning to increase the cash rate
by 25 basis points, to 5.75 per cent.

International developments
are continuing to provide stimulus to growth in Australia. The world
economy is growing at an above-average pace for the fourth successive
year and, significantly, forecasts have recently been revised upwards.
Commodity prices have been increasing strongly for some time, and they
have risen further in the year to date. This suggests a strengthening
in the outlook for Australia’s export earnings, with consequent
expansionary effects on incomes and spending.

In
Australia, domestic spending has been growing at a solid pace recently
and prevailing conditions suggest that this is likely to continue. High
profitability and rising share prices are indicative of a favourable
business environment in which investment growth is likely to remain
strong. There are also signs that the dampening effects of household
balance-sheet adjustment on consumer spending are starting to wane.

Recent
trends in credit growth indicate that households and businesses have
continued to find it attractive to borrow at prevailing interest rates.
After touching a low point in the September quarter, the growth of
household credit has picked up over the two most recent quarters.
Business credit growth has continued to trend upwards. A factor that is
likely to have contributed to the overall strength of credit growth has
been the continuing compression of lending margins by financial
intermediaries over recent years, reflecting competition among lenders.
As a consequence, although the cash rate has been close to its
historical average, interest rates paid by borrowers have remained
below average.

These domestic and international trends have
added to inflationary pressures in an economy that has been operating
for some time with rather limited spare capacity and low unemployment.
Wages growth, though not accelerating further recently, is higher than
it was a year ago, and businesses are continuing to report that
suitable labour is scarce. Raw materials costs continued to increase
strongly in the March quarter, reflecting the general strength in
global commodity prices. Consumer price inflation has picked up to
around 3 per cent in recent quarters. While this partly reflected
rising fuel costs, underlying consumer price inflation also increased
in the March quarter, to around 2¾ per cent, a rate it had not been
expected to reach until the second half of the year.

Taking all
of these developments into account, the Board judged at its May meeting
that inflationary risks had increased sufficiently to warrant an
increase in the cash rate.

Peter Fray

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