Australia's worst drought in recorded history will cut its wheat crop to its lowest level in 12 years and cut economic growth by around 0.7 percent, an official forecast said Friday.

The prediction came as Prime Minister John Howard said the "big dry" would put pressure on prices and said an interest rate hike might be best to contain inflation.

The drought will slash the gross value of farm production by 35 percent, or 6.2 billion dollars (4.7 billion US) in 2006-07, hurting Australia's stellar economic growth, the country's top commodities forecaster said.

In a revised crops estimate, the Australian Bureau of Agricultural and Resource Economics (ABARE) predicted wheat growers would face their smallest crop since 1994-95 as their harvest falls to 9.5 million metric tonnes.

"The drought is estimated to reduce economic growth in Australia in 2006-07 by around 0.7 percentage points from what would otherwise have been achieved," said ABARE's Executive Director Karen Schneider.

The forecast wheat crop of 9.5 million tonnes would be less than one third the size of the 2005-06 crop of 25 million tonnes, as a devastating drought that has plagued farmers for the past six years tightens its grip on economy.

It comes after the nation's monopoly wheat exporter ABB Ltd. this week slashed its production forecast by up to 40 percent to nine to 11 million metric tonnes from 12-15 million predicted last month.

ABARE said Production of barley and canola is also tipped to suffer, with the barley crop forecast to be 3.6 million tonnes this year, down 64 percent on a year ago, with canola tipped to fall to 440,000 tonnes, or 69 percent.

But Howard said the dry stretch would not have a major impact on overall economic growth.

"The aggregate impact on our gross domestic product will not be all that great," the prime minister told Southern Cross Broadcasting after around half the country's farming land was officially declared drought-stricken.

The reduction in agricultural output would be offset by other sectors of the economy, he said.

But Howard conceded the drought was already impacting prices and warned an expected interest rate rise next month may be justified to contain a bigger increase in the future.

Inflation came in at a higher-than-expected annual rate of 3.9 percent this week, ratcheting up expectations of a rate rise when the Reserve Bank meets in early November.

"I think an interest rate rise is entirely possible given inflation," Howard said, stressing that the decision was entirely up to the central bank.

"What you have to consider is that if you don't have an interest rate rise then it is possible there will be a further boost in inflation because of the strength of the economy and a bigger rise might be needed further down the track to contain the inflation."

Despite the drought, Australia enjoyed a "very strong, even exuberant economy" and that activity had contributed to inflationary pressure, he said.

"The Reserve Bank may well say that the best thing it can do for Australia is dampen that inflationary exuberance a little now, rather than to let it run, and if it does it may have to lift interest rates by a much bigger amount in order to dampen inflation," he said.

But later on in the day, Howard insisted he had not endorsed another interest rate rise.

"I'm simply acknowledging that the Reserve Bank will make the decision and I also make the point that controlling inflation is very important and the Reserve Bank has to keep that very much in mind," he told reporters.