Budget will help cap interest rates: Australia PM

CANBERRA, May 14 (Reuters) - Australia's Labor government on Wednesday said its first budget setting aside a record surplus to fund nation-building projects would also combat inflation and help cap a run of interest rate rises.

"Fiscal policy, or budget policy, has got to play its role," Prime Minister Kevin Rudd told Australian television as he and Treasurer Wayne Swan began a round of media interviews to sell centre-left Labor's first budget since 1995.

They have promised a A$21.7 billion ($20.4 billion) surplus in 2008/09, but with slowing economic growth and inflation to be higher than the previous forecast.

"Part of the problem in the past is we've had too much of a galloping increase in government spending," Rudd said.

Interest rates are currently at a 12-year high of 7.25 percent, with the independent Reserve Bank of Australia (RBA) raising them four times since last August in an effort to bring inflation back within its 2-3 percent target range.

Swan made the inflation fight the key theme of his budget statement on Tuesday, saying the A$41 billion set aside to fund nation-building projects would bolster flagging productivity.

However, analysts said that the budget's A$46 billion in tax cuts could have the opposite effect of buoying spending.

Rudd also warned the budget would result in a "modest increase" in unemployment, which has been at a 33-year lows around 4 percent, as the government trimmed growth forecasts to 2.75 percent.

Analysts and media commentators were mostly positive about the budget, which hit Australia's rich and aimed to repair Labor's reputation as poor economic managers before wresting power from the conservatives in November elections.

"Last night's budget represents, at most, a modest tightening of fiscal policy," said the Australian Financial Review newspaper. "The budget therefore will make little difference to inflation and interest rates in the coming year," the paper said.

The Age newspaper said the budget was primarily aimed at the RBA, saying the final judgement on it would be "whether the bank holds off further interest rates rises".

"Swan lite on inflation," said the Australian newspaper, saying Labor had begun dismantling middle class welfare in a budget delivering few surprises.

"The first Rudd budget is a great gamble that inflation can be conquered while working families are rewarded with a A$55 billion package to cushion their pain," the paper's veteran columnist Paul Kelly said.

Conservative Opposition treasury spokesman Malcolm Turnbull said the budget would add to inflationary pressure by lifting taxes and prices for alcohol, luxury cars, and private health insurance.

Moody's Investors Service said the budget was in line with the government's Aaa rating, as the promised tax cuts were affordable and forecasts for the coming fiscal year were credible.

"The Australian government, even relative to most other governments rated Aaa, has a strong financial position, with very little debt and growing financial assets," said Steven Hess, Moody's lead analyst for Australia. ($1=A$1.06) (Reporting by Rob Taylor; Editing by James Thornhill)

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