The Reserve Bank of Australia (RBA) continues to be wary of high inflation, but its acknowledgment that the economy is slowing has dampened expectations of further interest rate rises, economists say.
The minutes of the central bank's July board meeting, released today, said the RBA expected the June quarter consumer price index to show inflation of "over 1 per cent'' in the quarter.
"Members expected that the CPI for the June quarter, which would be released before the next board meeting, would show another high reading,'' the minutes said.
"These high outcomes risked lifting inflationary expectations and/or wage demands.
"If that occurred, it would make inflation more difficult to reduce over time.''
Westpac senior economist Andrew Hanlan said the RBA would be prepared to look through high inflation if it was just the result of the soaring cost of fuel.
"Provided the boost to inflation is really just the first round effect from higher petrol prices, then the Reserve will look through that number,'' Mr Hanlan said.
"The only concern is whether you would see a shift in wage and price behaviour more generally as a result and get an imbedded inflation problem.''
Mr Hanlan said there was still a risk high inflation outcomes in the near term could produce an upward lift in inflation expectations, but said this was unlikely given slowing demand.
"We expect rates will remain on hold for a long period,'' Mr Hanlan said.
The RBA left the official cash rate unchanged at a 12-year high of 7.25 per cent for the fourth straight month at its July 1 board meeting.
The RBA's has lifted interest rates four times since the beginning of August last year.
Also, the commercial banks have all moved their mortgage rates independent of the central bank's decisions, reflecting higher borrowing costs on wholesale money markets.
Private sector surveys have indicated the economy was slowing - business conditions dropped to their worst levels in six and a half years in June, while consumers were at their most pessimistic since January 1992 and jobs growth was trending lower.
Also, last week the Australian Bureau of Statistics said the number of home loan approvals recorded their biggest monthly fall in eight years in June.
"On balance, while members remained concerned about the current rate of inflation and the uncertainties about the outlook, the increasing signs that demand was slowing suggested that the existing policy setting was exerting the appropriate degree of restraint,'' the minutes said.
"Provided demand continued to evolve as expected, inflation was likely to decline over time.''
Mr Hanlan said the question of whether demand was slowing "had been answered''.
"Certainly the evidence is very clear that demand has slowed and slowed significantly so that's no longer an issue,'' Mr Hanlan said.
"We expect rates will remain on hold for a long period.''
In its most recent quarterly statement on monetary policy, the central bank said it expected an annualised underlying inflation rate of 4.25 per cent by June and four per cent by December.
It also projected underlying and CPI inflation to decline gradually in 2009 to around 3.25 per cent before falling to three per cent in 2010.
In the March quarter of this year, annualised underlying and CPI inflation clocked in at 4.2 per cent.
June quarter CPI is due on July 23.
Deutsche Bank senior economist Phil O'Donaghoe said the minutes showed the RBA was more confident that its tight monetary policy was working to slow the economy.
"Our assessment is that the Bank is increasingly comfortable that demand is going to slow, but it still got a tightening bias,'' Mr O'Donaghoe said.
"We're not there yet, but things are looking good.''
The RBA's next board meeting is on Tuesday, August 5.
