SYDNEY (AFX) - The Reserve Bank of Australia (RBA) said monetary policy is likely to continue to be biased towards rate increases, pending a stabilising in equity markets and an assessment of what impact this equity weakness had on the economy. In its statement on monetary policy, the RBA said it is difficult to predict what impact the equity weakness would have, although it felt it prudent to hold off on rate rises in June and August while the effects are assessed. "The size of such an effect will depend, among other things, on the extent to which business and consumer confidence in the major economies are affected, on the way businesses respond to a higher cost of equity capital, and also on whether markets stabilise near their recent levels or decline further. All of these things are inherently difficult to predict," it said. It noted that economic behaviour may not have fully adjusted to the run-up in share prices in the late 1990s so the impact of the subsequent decline could be somewhat limited. "It should also be noted that the equity market declines have occurred against a background of expansionary policy settings that will help to offset at least some of their impact, and that the asset price declines have not apparently seriously undermined the asset quality of the global banking system," it said. "At this stage, while acknowledging the uncertainties, the most likely outcome in the major economies still appears to be one of moderate growth, though at a slower pace than earlier thought," it said. The RBA said the Australian economy is continuing to grow more strongly than the major economies and appears to have maintained a good pace in the June quarter. "While the slowdown in the global economy in 2001 has been reflected in lower Australian exports, this has been compensated by the strength of domestic demand," it said. Household spending has been an important driver of domestic demand, and conditions are generally supportive of further good growth, with household income supported by rising employment and real wages while consumer confidence remains at a high level. It said housing construction has contributed to growth over the past year and, on the latest indications, is likely to remain at a high level in the second half of this year. The Australian business environment should contribute to a pick-up in investment spending, with the cost of external financing and overall level of corporate debt both remaining low. The RBA said the notable exception to the overall positive outlook for the Australian economy is the farm sector, with a number of areas affected by drought conditions, which are likely to have a detrimental effect on farm production and incomes. It said the June quarter CPI was consistent with the inflation forecasts presented in previous RBA statements, with few sources of pressure on business margins other than the continuing exception of rising insurance and utility costs. The RBA said inflation is likely to remain around 2.5 pct this year, within its 2-3 pct target band, although there were upside risks next year. "The bank's assessment is that underlying inflation is likely to remain around the middle of the target band in the second half of 2002. However, a continuation of the current pace of growth in the domestic economy would most likely see increased pressures on wages and prices over the course of 2003," it said. This inflation outlook is predicated on a modest global recovery, albeit at a slower pace than seemed likely a few months ago, it said. The RBA said its decision raising interest rates by 25 basis points in May and June, which took the cash rate to 4.75 pct, was appropriate to return rates to levels more consistent with the economy's more favourable circumstances. "However, the cash rate remained on the expansionary side of neutral," it said. The RBA said the weight of domestic economic indicators points to continued strong growth and inflation remaining in line with earlier forecasts, and while there was a case for rate rises in July and August, it decided to leave them unchanged as a precaution given the equity market weakness. "If the effects on growth of the global economy (of the equity market weakness), and consequently on Australia, turn out to be quite small, the case for further rises in interest rates would remain intact," it said. "While this appears the most plausible scenario, the possibility of a significant dampening impact of the financial turmoil on the global economy must be taken into account. Given these uncertainties, the board judged at both its July and August meetings that it was prudent to leave the cash rate unchanged," it said.