The Reserve Bank of Australia (RBA) has left interest rates on hold for the third month in a row but economists say rates could rise in August if domestic demand fail to slow fast enough.

The cash rate was left unchanged at a 12-year high of 7.25 per cent today, after the bank’s board meeting.

In an accompanying statement, the RBA hinted that rates could rise again.

“Should demand not slow as expected, or should expectations of high ongoing inflation begin to affect wage and price setting, that outlook would need to be reviewed,” RBA governor Glenn Stevens said.

The RBA said demand was likely to ease in 2008.

“On balance, the board’s current assessment is that demand growth will be moderate this year,” the statement said.

“In the short term, inflation is likely to remain relatively high, but it should decline over time provided demand evolves as expected.”

Commonwealth Bank of Australia senior economist John Peters said the RBA could put interest rates up again in August, if second quarter consumer price index (CPI) data, due on July 23, fail to show signs that inflation is moderating.

“We think the risks are that growth may not slow as the Reserve Bank requires it to, to ensure the CPI flops back to the (inflation) target zone,” he said.

“There’s a risk rate may move this year in the second half.”

Inflation has been above the RBA’s two to three per cent target since late 2007.

Official interest rates were raised in August, November, February and March to rein in inflation.

Both the RBA and the federal government expect Australia’s terms of trade to rise by 20 per cent in calendar 2008.

Treasurer Wayne Swan promised $7 billion worth of election tax cuts in the 2008/09 budget, which will come into effect on July 1.

ABN Amro senior economist Felicity Emmett said the RBA’s statement was very similar to that which followed the May board meeting.

“The slight difference being the Reserve Bank seems to be slightly more confident that the slowdown in demand is occurring,” Ms Emmett said.

“Previously they said they have been more tentative about the slowdown.

“Now they are saying there is a definitely a moderation in demand is occurring.”

Ms Emmett said the RBA was worried that high inflation expectations could be used as a bargaining chip by workers for higher wages.

“There is still the risk of expectations of high ongoing inflation may affect wages price setting behaviour,” Ms Emmett said.

“Now their main concern is that will it feed into wages as workers attempt to compensate for the high CPI by high inflation.”

Chief economist at funds manager Ausbil Dexia, John Honan, said the RBA recognised previous interest rate rises were having the desired impact.

“The domestic issues have been moving the way the Reserve Bank would want them to move, that is slowing in the interest rate sensitive areas,” Mr Honan said.

“I think it will be very pronounced by the end of 2008.

“And that will give the bank room to move I think.”

Mr Honan said today’s RBA statement was “consistent with what they’ve been saying in speeches”.

Mr Honan believed the official cash rate had peaked, despite the futures market continuing to price in more tightening.

“I think the bill market is offering value relative to where the cash rate will be through the course of the calendar year,” he said.

The RBA said there had been “subdued outcomes” in household spending over recent months and weaker credit expansion to both households and businesses.

But it remained wary about high ongoing inflation affecting wage and price setting should demand not slow as expected.

Mr Honan said inflation was a “worldwide phenomena”.

“The only concern I think is there’s a pervasive inflation risk generally now from commodity prices, from oil prices and the like,” Mr Honan said.

“Resources-based activity is still performing very well.

“Engineering activity is very strong.

“The whole terms of trade issue is very strong indeed.”

AAP