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RBA chief says inflation likely to remain low for some time

Published 1:05 PM, 28 Jul 2009 Last update 1:21 PM, 28 Jul 2009

By a staff reporter, with Reuters

Reserve Bank of Australia (RBA) governor Glenn Stevens says inflation is likely to remain low for a while, and Australians are becoming more optimistic about the country's economic future.

In a wide-ranging speech, the RBA chief said a near-term challenge was ensuring that the ready availability and low cost of housing finance was translated into more dwelling, not just higher prices.

"If we fail to do that ... then it will be very disappointing, indeed quite disturbing," Mr Stevens told a charity lunch in Sydney.

"Not only would it confirm that there are serious supply-side impediments to producing one of the things that previous generations of Australians have taken for granted, namely affordable shelter, it would also pose elevated risks of problems of over-leverage and asset price deflation down the track."

Mr Stevens said the dangers of too much borrowing chasing up asset prices had been all too evident in other countries.

"These risks have been reasonably contained so far in Australia, but it would be prudent not to push our luck here," he said.

The nation's top central banker said there was no rule that dictates the RBA had to wait for unemployment to peak before raising interest rates, adding to speculation the next move in rates is likely to be up.

Australia's unemployment rate is currently 5.8 per cent, while the official cash rate has been at a near-50-year low of three per cent since April.

Downturn less severe than feared?

Mr Stevens said while Australia had not managed to avoid an economic downturn, it might be less severe than feared.

"We cannot claim that Australia has avoided any downturn at all. It appears at this stage, however, that the downturn we are having may turn out not to be one of the more serious ones of the post-War era, in contrast to the experiences of so many other countries," he said.

"It is becoming more common for Australians to see the glass as half-full than as half-empty. Put another way, we can much more easily imagine upside risks to the outlook, to balance the downside ones, than was the case six months ago."

Mr Stevens said confidence had recovered some ground, noting upbeat business surveys, lower-than-expected unemployment figures, recent equity raisings, a pick-up in housing finance figures and a jump in the value of loan approvals by one-third since a low point in 2008.

Australia's ability to get through the past nine months of the downturn in reasonable shape ought to give the country "quiet confidence" in its ability to meet the current set of issues, Mr Stevens said.

Inflation rates likely to stay low

Mr Stevens also said rising public debt - gross public debt of G7 countries is likely to exceed 100 per cent of gross domestic product within the next year - and unconventional monetary policies undertaken by central banks across the world had prompted concerns about inflation.

"The aggressive, and in places unconventional, policy responses to the contraction in demand are seen by some observers as increasing the risk of inflation," he said.

"At a cyclical frequency, the global economic downturn has taken the pressure off prices for goods and services for the time being. Most likely, inflation rates in the developed world will continue to be low for a while."

He said finding the path between the unpalatable alternatives of deflation and inflation was the central challenge for policy-makers around the world over the next several years.

The headline consumer price index (CPI) rose 0.5 per cent in the June quarter, for an annual rate of 1.5 per cent.

Support for stimulus packages, unconventional monetary policies

In an address entitled 'Challenges for Economic Policy', Mr Stevens threw his support behind temporary stimulus packages delivered by governments throughout the world.

"Faced with a large downturn like this, it was the right thing to do to allow budgets to go into deficit. Over time, though, there will obviously need to be fiscal consolidation. This will be easier where the fiscal measures taken were temporary," he said.

Mr Stevens said constraints on economic policy were likely to last for some time, with higher debt burdens set to limit the extent to which worthwhile structural spending levels can be maintained for health, education and urban infrastructure.

Mr Stevens also warned that while the federal government's bank guarantee - which gives banks access to the government's AAA-credit rating - had played a critical role in stabilising confidence in the financial system, it was "undesirable as a permanent feature of the landscape".

"Part of the way ahead will, at some point, involve winding back the extensive government guarantees (and in some cases extensive public ownership) of financial institutions around the world," Mr Stevens said.

Australian banks have accounted for 10 per cent of global issuance of government guaranteed bank debt over the past nine months.

Mr Stevens said the shape of global capital markets was changing significantly, with government and government-guaranteed debt rapidly increasing globally.

"But the longer-term question is whether ... we would really want to keep moving in the direction of a world where the bulk of debt is government-issued or government-guaranteed," he said.

"It seems to me that that could easily be a world in which investors end up being no more discerning about risk and return than the buyers of CDOs [collateralised debt obligations] a few years ago, and in which banks themselves rely on the guarantees to an inappropriate or even dangerous extent."

"It would be preferable, in my judgement, to work at making the (global financial) system more effective in doing that job, than to retreat into the financial repression of an earlier state of the world."

Commodity prices

Mr Stevens said another challenge for Australia would be if global commodity prices remained at elevated levels, as was possible given demand from emerging economies like China.

In that case the mining and resource sectors of the Australian economy would likely expand further, while other sectors would tend to contract, leading to imbalances, he said.

"Moreover, if we are more integrated into China's expansion, we will be similarly more exposed to the consequences of whatever might go wrong in that country," Mr Stevens said.



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