Howard's comments came as Australia's leaders scramble to limit the political and economic fallout from a disastrous drought that has been steadily tightening its grip on the driest continent on earth over the past six years.

While the country's worst drought in at least a century will impact farming income, Howard said the reduction in agricultural output would be offset by other sectors of the economy.

"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.

Two weeks ago, Howard warned that the "big dry" would take some lustre off Australia's stellar economic growth but refused to be drawn on the extent of the impact.

Treasurer Peter Costello has warned the drought could drive farm production into recession.

The country's wheat export monopoly AWB Ltd on Wednesday cut its production forecast for the world's third largest exporter by up to 40 percent as crops come under pressure from the drought.

With a long, dry summer predicted, it slashed its forecast for the third time this year to nine to 11 million metric tonnes of wheat from the 12-15 million forecast last month.

Howard on Friday conceded that the effects of six years of below average rainfall would have some impact on prices.

"It's already starting to have some impact," he said, warning that an expected interest rate rise next month may be necessary to contain a bigger increase in prices 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," Howard continued.

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.

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