By Jacob Greber
Oct. 30 (Bloomberg) -- Australia's inflation rate may limit the central bank's scope to cut borrowing costs, said Deputy Governor Ric Battellino, prompting traders to pare bets on the size of next week's potential interest-rate reduction.
Australia will avoid a recession and still has ``a big task ahead to bring inflation down and this could limit room for maneuvering on monetary policy,'' Battellino told a conference in Sydney today.
Investors had earlier been betting the Reserve Bank of Australia would cut borrowing costs by more than half a point next week to protect the economy amid the global financial crisis. The U.S. Federal Reserve cut its benchmark rate yesterday by half a point followed today by Taiwan and Hong Kong.
``The message here is that the market has got too much priced in'' for another 125 basis points of cuts by Christmas, said Su-Lin Ong, senior economist at RBC Capital Markets Ltd. in Sydney. ``The Reserve Bank will deliver 50 points next week and we think maybe another 25 points in December.''
Policy makers led by Governor Glenn Stevens reduced the overnight cash rate by 1 percentage point this month to 6 percent, the biggest cut since a recession in 1992.
The Australian dollar rose to 67.53 U.S. cents at 11:37 a.m. in Sydney from 66.48 cents just before the speech was published. The two-year government bond yield fell 1 basis points to 4.22 percent. A basis point is 0.01 percentage point.
Avoiding Recession
Traders also pared bets that Stevens will lower borrowing costs by as much as 75 basis points on Nov. 4, according to a Credit Suisse index based on overnight swaps trading. The chance of a 75 point cut fell to 39 percent today from 82 percent yesterday, according to the gauge.
Battellino said policy makers are aiming to ensure Australia repeats its experience of 2001, when it sidestepped a global recession. ``That is certainly what we're aiming for, and there is nothing in the data to suggest that we are off track,'' he added.
Still, the task of managing the economy through the current turmoil, which prompted the Federal Reserve to cut its benchmark interest rate yesterday to 1 percent, will be more difficult than in 2001 ``because we are starting with a bigger inflation overhang,'' Battellino said.
Inflation accelerated in the third quarter to the fastest pace since 2001, rising 5 percent from a year earlier as costs for housing and food jumped, a report showed on Oct. 22.
Mining Boom
``Inflation has got a long way to fall'' to get back within the central bank's target range of 2 percent to 3 percent, Battellino said. ``It's very important in the long run that that happens. If inflation remains high, it starts to distort how the economy works.''
The economy is in its 17th year of expansion, stoked by a mining boom that has helped push unemployment close to the lowest in more than three decades and boosted household incomes by the most in 30 years. Unemployment is now rising and prices for coal, iron ore and Australia's other mineral resources are falling.
``The economy cannot always grow above average and it certainly cannot maintain the pace of the past five years,'' Battellino said.
``If we attempted to make it do so, we would be repeating the mistakes of our predecessors in the 1960s, whose attempts to maintain a never-ending boom laid the foundations for the subsequent two decades of severe economic difficulties.''
Household Income
Over the past five years, the amount of money that Australian households had left to spend, after paying taxes and interest on all their loans, grew in real terms by 25 percent, the biggest increase in more than 30 years, Battellino said.
``This growth in household incomes in Australia greatly exceeded that in any other developed country. In the U.S., for example, growth in real household disposable income was only about half that in Australia,'' the deputy governor said.
Still, Battellino said it's ``reasonable to assume'' that income growth for households will be ``noticeably below average over the next year or two.''
There are increasing signs that economic growth is slowing. Gross domestic product rose 0.3 percent in the second quarter from the previous three months, the smallest increase in more than three years, after consumers cut spending for the first time since 1993.
Battellino said policy makers ``just don't know'' what the effects of the global credit squeeze that has roiled financial markets will be on Australia's economy.
`In Good Shape'
``While nobody can predict accurately all that lies ahead, it is important not to become too pessimistic,'' he said. ``Fundamentally, household finances and the economy more generally remain in good shape.''
Australian Prime Minister Kevin Rudd told Fairfax Radio today that while the global financial crisis represents ``a real threat to growth and jobs in Australia,'' the most recent government figures suggest ``positive economic growth into 2009.''
Battellino also questioned some commentators who have looked at the U.S. housing market ``and seen the future'' for Australia.
House prices are unlikely to follow America's plunge as the local property boom, which Battellino said was ``hottest in 2003,'' didn't result in an oversupply of unsold new homes.
To contact the reporters for this story: Jacob Greber in Sydney at jgreber@bloomberg.net
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