The Australian economy has suffered its worst contraction in 20 years but a surge in business investment will provide the next stage of growth and keep the Reserve Bank on track to raise interest rates in the next few months.

The March quarter national accounts, published yesterday, show the economy shrank by 1.2 per cent after the Queensland floods and Cyclone Yasi dragged the economy into the red.

The most damage was caused by a 27 per cent fall in coal exports, and the floods shaved 1.5 to 2 per cent off growth in the quarter.

The result was just the fourth contraction in the past 20 years and the worst since the peak of the 1991 recession. However the result surpassed expectations that the economy could shrink by up to 1.4 per cent.

It prompted the dollar to rise to $US1.0732 before falling to $US1.0722. Last night, the currency was higher at $US1.0742.

There was speculation yesterday that a Latin American central bank was buying the Australian dollar to diversify out of its greenback holdings.

The Australian dollar has become one of the most bought currencies in the world by central banks. The Australian equities markets showed little reaction, with the S&P/ASX 200 and the All Ordinaries finishing flat.

However, the markets are warming towards an interest rate rise in the next few months. The interbank futures market predicts there is a 13 per cent chance of a rise next week, up from just 2 per cent on Tuesday.

Most economists expect an interest rate rise by August.

The national accounts show that despite the contraction, there were strong patches in the economy, with private demand up by a surprising 1.3 per cent. Business investment grew by 2.8 per cent, which economists expect will strengthen.

Royal Bank of Scotland chief economist, Kieran Davies, said there were investment projects under way worth an “unprecedented” 12 per cent of gross domestic product. There are projects under consideration worth 18 per cent of GDP.

“Most of the strength is in the mining sector where export prices continue to rise . . . it points to a pick-up in business borrowing after a long period of deleveraging after the global financial crisis,” Mr Davies said.

“We think that the biggest issue for investment will be getting all the work done and the huge pipeline of projects could see skill shortages in the next year or two.”

UBS chief economist Scott Haslem said the contraction would not deter the RBA from raising interest rates because the business investment surge could stoke inflation.

Wages in the March quarter grew by 2.9 per cent, the most rapid pace in more than a year, and could rise further on the back of the higher investment levels.