Tobacco tax rise superheats Oz inflation

SYDNEY - Annual inflation rose to a 19-month high last month following a tax increase on cigarettes, with further pressures expected on prices as the Australian economy strengthens, a survey says.

The 0.5 per cent increase in the TD Securities-Melbourne Institute monthly inflation gauge followed rises of 0.4 per cent in April and 0.5 per cent in March.

In the year to May, the inflation gauge rose by 3.7 per cent, its highest annual rate since October 2008.

"While there is a spike in the headline measure due to the 25 per cent lift in the tobacco excise, excluding this outcome still sees headline inflation breaching the upper limit of the RBA's [Reserve Bank of Australia] 2 to 3 per cent inflation target band," TD Securities senior strategist Annette Beacher said.

"The underlying or trimmed measure of inflation has soared to 3.5 per cent in the year to May."

Omitting the rise in tobacco as a result of the tax increase in late April, the inflation gauge rose by 0.1 per cent in May for a yearly rate of 3.3 per cent.

This was still above the RBA's target band, which it uses monetary policy, or interest rates, to keep inflation within during the economic cycle.

Beacher said underlying inflation, which removes volatile price movements, was consistent with an economy that is fully employed and would tighten as economic growth increased during the year.

"While there is a need to be aware of ongoing negative offshore headwinds, domestic price pressures must steady the RBA hand for now," she said.

"The markets are clearly overshooting by pricing in a material risk of a rate cut in the coming months, but with a fully employed economy and price pressures clearly building up a head of steam, a rate cut is the last thing this economy needs."

Beside tobacco, increases in the costs of fuel and financial services offset falls in the prices of fruit and vegetables, holiday travel and accommodation, and sport and other recreation during May.

Professor Don Harding, of La Trobe University's Department of Economics and Finance, said prices rose in 21 spending groups during May and fell in 13.

"In the short run, international considerations will most probably preclude further tightening of monetary policy," Harding said.

TD Securities expect the central bank to keep the cash interest rate at 4.5 per cent after its board meeting today, but forecast another 0.75 percentage points in rises to 5.25 per cent by December.

- AAP