By Stella Qiu
SYDNEY (Reuters) -Australia's central bank on Friday revised up its forecasts for core inflation and wages growth and warned of further increases in interest rates, raising the risk the economy could slip into recession.
In a hawkish-sounding quarterly Statement on Monetary Policy, the Reserve Bank of Australia (RBA) said domestically-sourced cost pressures were still picking even if consumer price inflation was a whole may have finally peaked last quarter.
While growth in global goods prices had cooled this was yet to show clearly in Australia, while inflation in the service sector had climbed faster than expected.
"The Board expects that further increases in interest rates will be needed to ensure that the current period of high inflation is only temporary," said the RBA, implying two or more hikes were waiting in the wings.
"Given the importance of avoiding a price-wage spiral, the Board will continue to play close attention to both the price-setting behaviour of firms and the evolution of labour costs in the period ahead."
On Tuesday, the RBA raised its cash rate for the ninth straight time to a fresh decade-high of 3.35%, bringing the total tightening since last May to a whopping 325 basis points.
It also surprised markets by signalling further increases were needed, quashing talk of a pause and leading markets to sharply revise up their outlook for terminal rates to 4%, after a shock fourth-quarter inflation report. <0#RBAWATCH>
"Today's SOMP showed a surprisingly hawkish inflation outlook," said George Tharenou, chief economist at UBS. "The extra hawkishness in today's SOMP means we change our view again to two more 25bps hikes."
Tharenou now sees rates peaking at 3.85%, compared with 3.35% previously, and says the risk of recession in the second half this year has increased materially to about 25%.
Consumer price inflation is running at a 32-year high of 7.8% and is now expected to only slow to 6.7% by June this year, up from a previous forecast of 6.3%. It should then slow further to the top of the RBA's target range of 2-3% by mid-2025.
The closely-watched trimmed mean measure of inflation will only slow to 6.2% by the middle of this year, compared with a previous forecast of 5.4%.
Annual wage growth is expected to pick up to a peak of 4.2% at the end of this year, compared with the previous forecast of 3.9%, before easing back to 3.8% by mid 2025.
RBA's business liaison programme found around one-third private sector firms reported an above 5% increase in wages in the December quarter.
The unemployment rate is expected to steadily increase to 4.4% by mid-2025, from the current 3.5%.
All these forecasts are based on the technical assumption that interest rates peak at around 3.75% in mid-2023 before easing back to around 3% to June 2025.
The bank also raised its forecast of economic growth this year to 1.6% this year, compared with 1.4% previously. China's abrupt elimination of COVID curbs has added to growth in global demand, supporting Australia's terms of trade and national income.