Australia's central bank this week held interest rates steady, as fears of a fresh global financial crisis outweighed local concerns over inflation and a mining investment boom.
In a quarterly statement on Friday, the central bank voiced concern over sovereign debt problems in Europe and the United States and the possibility of global recession.
"There is ample scope to cut the policy interest rate and provide liquidity support for banks," the IMF said in its annual health check of the Australian economy.
It said the Australian dollar was overvalued somewhere between 10 and 20 percent, but noted the currency would probably depreciate if global conditions deteriorated.
The Aussie dollar suffered heavy losses on Friday and was among the week's worst performers in major currencies after investors fled to the safety of cash and bonds.
Still, the IMF said that if a global recovery does stay on track, Australia would likely need to raise its cash rate to contain inflationary pressures stemming from its mining boom.
Without further tightening, inflation would rise above the central bank's 2-3 percent target band in 2012, the fund said.
"The (central bank) should guard against inflation expectations becoming anchored at too high a level," the IMF cautioned.
The IMF forecast Australia's economy to grow 2 percent this year and 3.5 percent next year, compared with revised central bank forecasts of 3.25 percent for 2011 and 3.75 percent for 2012 and 2013.
Australian Treasurer Wayne Swan welcomed the IMF report, using it to bolster his argument that the nation was well placed to ride out another global financial crisis.
"The IMF's views are a timely reminder of Australia's strong fundamentals given the recent heightened concerns about the global economic outlook," Swan said in a statement.
(Reporting by Lesley Wroughton in WASHINGTON and Morag MacKinnon in PERTH; Editing by John O'Callaghan and Mark Bendeich)
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