The Reserve Bank of Australia (RBA) expects a slowing economy will eventually rein in inflation, but is banking on the Rudd government to deliver its promised spending cuts.

In Friday's quarterly monetary policy statement, the RBA slashed its economic growth forecasts for the period to 2010 but jacked up its short-term inflation predictions in anticipation of further price pressures.

While it said the current level of interest rates was appropriate, it indicated it would have little tolerance for flow-on effects of high inflation, such as excessive wage demands.

In the 68-page document, the RBA said it expected a moderation of demand from the public, or government, sector.

"Public demand growth is assumed to moderate somewhat from the relatively strong pace of recent years, reflecting slower growth in spending by both the commonwealth and state governments," it said.

Treasurer Wayne Swan will hand down his first budget next Tuesday against a backdrop of a slowing economy, a 16-year high in underlying inflation and a 12-year high in interest rates.

"What our budget will do will be to strike the right balance, to have sustainable growth with lower inflation and lower interest rates in the long term," Mr Swan told reporters in Canberra.

Prime Minister Kevin Rudd warned that interest rates would rise if his government didn't fight inflation with a responsible budget.

"If we fail to do that, mortgages will go up," Mr Rudd told Fairfax Radio Network.

"If we fail the fight on inflation, then we are basically hauling up the white flag when it comes to all those other cost-of-living pressures which families are struggling with right now," he said.

The RBA's latest forecasts show that inflation will get worse in the short term and then take a long time to mend.

It jacked up its consumer price index forecast for 2008 by a full percentage point from the February prediction to 4.5 per cent, and does not see a return to its two to three per cent inflation target until end-2010.

"This assessment would need to be reviewed if the expected moderation in domestic demand does not occur, or if expectations of high ongoing inflation begin to affect wage and price setting," it said.

Its revisions were something of a surprise given that only last month RBA governor Glenn Stevens had indicated there was scope to cut its forecasts given the early signs of a slowdown in domestic demand.

But that was before the CPI for the March quarter - released late last month - soared to 4.2 per cent and average underlying inflation struck a fresh 16-year high of 4.25 per cent.

The RBA also expects a "substantial" stimulatory boost from a 20 per cent increase in national income through the country's terms of trade, based on the latest contract negotiations for coal and iron ore.

At the same time the central bank said it expected a period of below-trend economic growth. It slashed the domestic product growth forecast for 2008 by a full percentage point to 2.25 per cent for the current year and projects growth in the range of 2.5 to 2.75 per cent through December 2010.

"Any evidence over the next three to six months that the bank's required slowdown is not happening will soon lead to a very sharp change in the current soothing rhetoric and another rate hike will ensue," Westpac chief economist Bill Evans said.