The Reserve Bank of Australia has rung an alarm over inflation, and financial markets now think further interest rate rises over the next 12 months are likely. Following three weeks of economic releases showing consumer and business spending is accelerating, RBA chief economist Malcolm Edey warned yesterday that the economy was reaching the limits of its capacity. Markets had all but dismissed the chance of further rate rises since the release of the December quarter consumer price index, showing the quarterly pace of inflation had plunged. But Dr Edey told a Sydney conference yesterday the bank's official forecast that inflation would drop from 3 per cent to 2.75 over the next two years should not be interpreted to mean the battle had been won. "This outlook is still higher than ideal: it implies inflation is more likely to be too high than too low in the period we can foresee. "Information that has become available since that forecast was made suggests some of the factors pushing up underlying inflation last year remain in place." Financial markets responded instantly, raising the chance of a rate rise at its next meeting from zero to 8 per cent with a 60 per cent probability of a further rate rise over the next 12 months. Westpac chief economist Bill Evans said Dr Edey's annual speech to a conference on the outlook for Australia and Japan traditionally focused exclusively on global issues but had been changed to shake the market out of its complacency. "The bank has decided to send a message," Mr Evans said. Dr Edey focused on wage and national accounts figures which have emerged since it completed its last review in February. Dr Edey cast the latest wage figures in a much more critical light than did bank governor Glenn Stevens at a recent parliamentary hearing. Whereas he said increases "in the low fours" were acceptable, Dr Edey said the official wage price index increase of 4 per cent in the year to December was artificially depressed by the delayed Fair Pay Commission award. But the 1.1 per cent December quarter rise, which was unaffected by this delay, was the highest since the index was introduced in 1998. The RBA did not believe the official GDP growth figures showing the economy had been expanding at little more than 2 per cent over the past two years. Dr Edey said the December quarter accounts, showing non-farm GDP growth of 3.5 per cent, were more consistent with the rapid employment growth. "The economy has had a lengthy period of expansion. The economy has moved closer to full capacity, with recent indicators pointing to stronger conditions in the second half of last year." Dr Edey said the December quarter national accounts showed that spending by consumers and business was growing faster than the economy's ability to produce, extending a trend that had been in place for several years. The faster December quarter growth had raised productivity growth to 1.5 per cent, which was close to its long-run average rate, although less than was being achieved in the 1990s. Dr Edey said the RBA would examine the strength of demand, output and wages in its monthly consideration of inflation. Meanwhile, US consumer price figures last night showed a rise of 0.4 per cent in February, signalling inflation slightly above market expectations. The CPI was stronger than the 0.3 per cent expected. But the "core" CPI index, which excludes volatile food and energy costs, was up 0.2 per cent, in line with forecasts. Source: The Australian