IMF sees Australia inflation risk- urges vigilance

SYDNEY, July 10 (Reuters) - Australia's economic growth could prove to be stronger than anticipated due to a boom in commodity exports, says the IMF, meaning policy makers should be ready to raise interest rates again to curb inflation.

In its latest report on Australia, the International Monetary Fund said it shared the Reserve Bank of Australia's (RBA) view that the economy was starting to slow in the face of higher interest rates and record petrol prices.

However, the IMF felt growth could turn out to be stronger than expected thanks to a recent jump in the price of Australia's major commodity exports, sizable immigration flows, and an increase in state infrastructure spending.

"On inflation, the risks are clearly on the upside," warned the IMF. "Further increases in energy prices are in the pipeline and capacity constraints, especially in the mining and housing sectors, could push inflation higher than envisaged."

Core inflation hit a 17-year high of 4.2 percent in the first quarter, well above the RBA's 2 to 3 percent target zone. The central bank has lifted rates four times in the past year to cool the economy and recently sounded more confident that it had done enough to restrain price pressures over time. The IMF, however, saw little room for error.

"Reducing inflation back within the target range will require a significant easing in domestic demand growth," said the report, posted on the IMF's Web site on Thursday.

"With the risks to inflation on the upside, the RBA should be prepared to tighten quickly if leading indicators suggest domestic demand will not slow as expected or the outlook for inflation deteriorates," the IMF warned.

The IMF saw no reason for the central bank to abandon or loosen its inflation targeting regime, as some have called for.

"Despite the pickup in short-term inflation expectations, the absence to date of a notable acceleration in wage inflation demonstrates that the RBA's inflation target has helped to anchor medium-term inflation expectations," said the report.

The IMF also approved of the Australian government's policy of building large budget surpluses, which has allowed to pay off foreign debt.

"This leaves Australia with a strong fiscal position, an enviable situation by international standards," said the IMF. "We support the strategy in the latest budget to save the revenue windfall from the commodity-driven boom and thereby allow automatic stabilizers to support monetary policy."

The global watchdog recommended that future budget surpluses be used for a combination of lower labour and capital income taxes, along with increased public investment. (Reporting by Wayne Cole; Editing by James Thornhill)