Australia’s Stevens Focuses on Inflation as Cuts End

By Jacob Greber

May 6 (Bloomberg) -- Australia’s record round of interest- rate cuts may be close to an end as central bank Governor Glenn Stevens focuses on the threat of inflation caused by surging government spending and borrowing costs at a 49-year low.

Much of the effect on the economy of six interest-rate cuts and almost A$90 billion ($67 billion) in government spending on infrastructure, bond-market guarantees and cash handouts to consumers since September are “yet to be observed,” Stevens said yesterday, when he kept the benchmark rate at 3 percent.

While Australia has fallen into its first recession in two decades, Stevens signaled that he expects the stimulus, lower rates and a pickup in China to boost demand this year. A report two weeks ago showed core inflation held above the central bank’s target range of between 2 percent and 3 percent in the first quarter.

“For the longer-term sustainability of a recovery, it’s all about inflation,” said Adam Carr, senior economist at ICAP Australia Ltd. in Sydney. “And the best way to keep inflation in check is to withdraw stimulus before the recovery takes hold, at the fist signs of stabilization, which is what we’ve got.”

Stevens said yesterday that while inflation is likely to abate, “this is occurring only gradually so far as the effects of the decline in the exchange rates are pushing up some prices.”

The Australian dollar tumbled in the three months through March for a third straight quarter. The currency traded at 73.85 U.S. cents at 9:29 a.m. in Sydney, 25 percent below its 25-year high of 98.50 cents on July 15 last year.

Core Inflation

The weaker currency is keeping upward pressure on the cost of imported goods and services such as gasoline and cars, even though the economy is probably in its first recession since 1991.

Australia’s weighted median index, a gauge of core inflation published by the Reserve Bank of Australia on April 22, showed prices rose 4.4 percent in the first quarter from a year earlier.

By contrast, U.S. consumer prices posted their first annual decline since 1955, falling 0.4 percent in March from a year earlier. Japan’s prices dropped an annual 0.1 percent, the first decrease in more than a year.

“Core inflation is still above 4 percent, even though by all reports we’re in a recession,” said ICAP’s Carr. “That’s a problem.”

Unlike counterparts in the U.S., Canada and New Zealand, who signaled in recent weeks that borrowing costs will remain low for some time, Stevens made no specific reference yesterday to the timing of any future rate moves.

Global Rates

“In assessing whether further reductions in the cash rate are required over the period ahead, the Board will monitor how economic and financial conditions unfold, and how they impinge on prospects for a sustainable recovery in economic activity,” he said.

By contrast, New Zealand central bank Governor Alan Bollard said on April 30 that he won’t raise borrowing costs before late in 2010. Bank of Canada Governor Mark Carney said on April 28 he intends to keep his main interest rate at a record-low 0.25 percent until the end of June 2010.

The U.S. Federal Reserve said on April 29 that its benchmark rate, close to zero, will probably remain “exceptionally low” for an “extended period.”

Australia has reduced its benchmark lending rate by a record 4.25 percentage points since early September to spur an economy that unexpectedly shrank 0.5 percent in the fourth quarter, the first decline in eight years.

“The stance of monetary policy, together with the substantial fiscal initiatives, will provide significant support to domestic demand over the period ahead,” Stevens said yesterday.

Home Loans

“It’s hard to escape the conclusion that the Reserve Bank will be hiking interest rates through 2010,” Tim Toohey, chief economist at Goldman Sachs Group Inc. in Melbourne.

The tone of Stevens’ statement yesterday “suggests the Reserve Bank will be reluctant to deliver additional interest- rate cuts this year,” Toohey added. The bank “is emphasizing fewer downside risks and placing more weight on the idea of economic recovery through 2009.”

Recent reports support Stevens’ view that lower borrowing costs and government spending are already reviving the economy. Home-loan approvals rose for a fifth month in February and consumer confidence jumped in April by the most since August. Business sentiment gained in March for a second month.

Mortgage Savings

A separate report published yesterday by the Australian Industry Group showed the services industry shrank in April at a slower pace for a second month as companies reported an increase in sales, new orders and deliveries.

“Monetary policy has been eased significantly,” Stevens said. Market and mortgage interest rates “are at very low levels by historical standards, and business loan rates are below average, reducing debt-servicing burdens considerably.”

Households with an average-sized mortgage of A$250,000 are paying A$7,000 a year less than they were six months ago, which is equal to 8 percent of average family incomes, according to the Reserve Bank.

Stevens also said that while the near-term outlook for the global economy “remains weak,” there are further signs of stabilization in several countries.

“The Chinese economy in particular has picked up speed in recent months and many commodity prices have firmed a little,” he said. China is Australia’s largest trade partner.

Investors have trimmed bets on the size of future Reserve Bank rate cuts, according to a Credit Suisse Group index based on swaps trading. Traders predict the benchmark rate will be 10 basis points lower in 12 months, the index showed at 9:36 a.m. in Sydney, down from 28 basis points early yesterday, and 41 basis points on April 28.

To contact the reporter for this story: Jacob Greber in Sydney at jgreber@bloomberg.net