The Reserve Bank of Australia (RBA) seriously considered raising interest rates in May and economists say that means rates could climb again in 2008 if domestic activity fails to moderate.

At the central bank’s May 6 board meeting, its members debated whether monetary policy was “sufficiently restrictive to secure low inflation over time”, given inflation is forecast to remain above its target band of two to three per cent over the medium term until 2010.

“Members spent considerable time discussing the case for a further rise in the cash rate,” the minutes for the board’s May meeting, released at 1130 AEST today, said.

The Australian dollar surged to a fresh 24-year high of 95.72 US cents within eight minutes of the RBA minutes release.

Ultimately, the RBA decided to leave the official cash rates unchanged at a near 12-year high of 7.25 per cent, but remained wary of inflation resulting in demands for higher wages and increased prices.

“Should demand not slow as expected or should expectations of high ongoing inflation begin to affect wage and price setting, the outlook, and the stance of policy, would need to be reviewed,” the minutes said.

Commonwealth Bank of Australia chief economist Michael Blythe said the fact the RBA had spend “considerable time” debating the need for a rate rise was a sign rates could rise again if economic activity did not slow down.

“Any sign the domestic side of things picks up, you’ll see a rapid interest rate response … if the economic data starts to show a sign of life again,” he said.

“You might need to see a month or two of data that shows that inflation is uncomfortably high and the economy is not slowing enough to restrain inflation.”

Mr Blythe said the RBA could raise interest rates in August if the late-July release of June quarter consumer price index data was still on the high side.

The RBA, which lifted rates in February and March, said it kept the cash rate on hold in May because higher borrowing costs would have the potential to slow down economic activity.

“But on balance, given the substantial tightening in financial conditions since mid-2007, and the extent of uncertainty surrounding the outlook, the board decided that it was appropriate to allow the current setting of monetary policy more time to work.”

The board minutes said with inflation remaining above four per cent for much of 2008, this carried the risk that “expectations of high ongoing inflation could develop, which could in turn affect price- and wage-setting behaviour”.

In its quarterly statement on monetary policy, the central bank said 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.

ANZ senior strategist Sally Auld agreed the RBA could lift interest rates again in August.

“There’s no doubt they’ve very hawkish,” she said.

“They tell us the key risk to interest rates in the next six months or the rest of 2008 is definitely to the upside and the Reserve Bank is signalling to us a zero tolerance to inflation and growth.

“The case for a rate rise is very close to being fulfilled.

“I think they’ll be reluctant to go before the June (quarter) inflation numbers … they’ll probably go in August.”

Ms Auld said the global credit crunch was becoming less of an issue, which meant the major banks were “potentially” less likely to raise their variable lending rates beyond moves in the official cash rate.

JPMorgan economist Helen Kevans said interest rates could rise again between July and late December if domestic demand failed to show signs of easing.

“Given the terms of trade boom and the tax cuts, the Reserve Bank may not get the easing in domestic demand it hoped for and rates could go higher later in the year,” she said.

“There’s much more chance of rates going up than down.”

Ms Kevans said the RBA was more likely to keep rates on hold in 2008, even if June quarter CPI data is high.

“The likelihood of a rate cut soon is very, very small,” she said.

“I don’t think the Reserve Bank would respond to high CPI but I think they’ll be watching for signs domestic demand is easing.

“If domestic demand is easing as they expected, the Reserve Bank is on hold for the rest of the year.”

AAP