Australia's central bank warns inflation too high, 'decisive' action needed

© Reuters. FILE PHOTO: An ibis bird perches next to the Reserve Bank of Australia headquarters in central Sydney, Australia February 6, 2018. REUTERS/Daniel Munoz/

SYDNEY (Reuters) - The head of Australia's central has warned inflation is set to rise much higher than expected just a month ago and policy needs to respond in a "decisive" manner, which is why the bank delivered an outsized rate hike early in June.

In a rare television interview on Tuesday night, Reserve Bank of Australia (RBA) Governor Philip Lowe said consumer price inflation was now likely to reach 7% by the end of the year, from the current 5.1% pace.

That was up sharply from a previous forecast of 5.9% and would be the highest reading since mid-1990. It is also far above the RBA's long term target range of 2-3%.

"That's a very high number and we need to be able to chart a course back to 2 to 3% inflation," Lowe said on Australian Broadcasting Corp. television.

"With inflation being as high as it is and when interest rates are as low as they are, we felt it was important to take a decisive step to normalise monetary conditions and we did that at the last meeting."

The RBA surprised earlier this month by lifting the cash rate by 50 basis points to 0.85%, twice as large as many had expected. Lowe made it clear there was more tightening to come.

"I think it's reasonable that the cash rate gets to 2.5% at some point," he said. "How fast we get to 2.5%, and indeed whether we get to 2.5%, is going to be determined by events."

Uneasy investors are wagering heavily the RBA will hike by another 50 basis points in July and August, and have rates reaching as high as 3.5% by the end of the year.

That aggressive outlook comes amid a rout in international markets on fears global interest rates will have to rise so aggressively they will tip the world into recession.

The U.S. Federal Reserve holds its policy meeting on Wednesday and speculation is intense it will hike rates by a drastic 75 basis points given the speed of inflation.

Lowe said inflation in Australia would not start to slow until the first quarter of next year, but he was confident that tighter policy would ultimately bring it down.

"What we've got to do is make sure inflation comes back to 2 to 3%," he added. "And it's unclear at the moment how far interest rates will need to go up to get that."