RBA’s View Economy to Absorb Rebuild Doesn’t End Inflation Risk

Reserve Bank of Australia Governor Glenn Stevens’s view that rebuilding flood-devastated areas won’t stoke inflation doesn’t diminish the chance that he will resume raising interest rates by midyear, economists said.

Stevens and his board left the overnight cash rate target at 4.75 percent in Sydney yesterday and said in a statement that reconstruction of Queensland and elsewhere on the east coast is “unlikely to have a major impact” on inflation this year.

Economists from banks including Citigroup Inc., HSBC Holdings Plc and JPMorgan Chase & Co. indicated the bond market is underestimating the odds of a rate rise by June, with interbank futures on the Sydney Futures Exchange reflecting less than a 20 percent chance of a quarter-point move. Unemployment near a two-year low of 5 percent in December may fall further, they said.

“The labor market is tightening, the global economy is strengthening and mining investment is likely to remain strong,” said Gavin Stacey, head of Australia and New Zealand research at Barclays Capital in Sydney, who expects a rate increase as early as April. “That combination makes it pretty hard to argue that inflationary pressures are subsiding, and the market pricing seems to be a little bit light on.”

Traders are betting there is a 16 percent chance Stevens will increase rates by a quarter percentage point to 5 percent in June, according to Bloomberg calculations based on interbank futures on the Sydney Futures Exchange. Inflation-linked government bonds today calculated consumer-price gains will average 2.87 percent over the coming five years, within the central bank’s target.

Inflation Slows

The RBA drew confidence from the slowest consumer price increase in almost two years last quarter and a deceleration of economic growth as households boost savings.

In his statement yesterday, Stevens said the deluge is having a “temporary adverse effect.”

“In setting monetary policy the bank will, as on past occasions where natural disasters have occurred, look through the estimated effects of these short-term events on activity and prices,” he said.

A government report last week showed Australian consumer prices advanced 0.4 percent in the final three months of last year from the prior quarter, and 2.7 percent from a year earlier. That’s within the RBA’s target range of 2 percent to 3 percent on average.

A report today from the Canberra-based Housing Industry Association showed sales of newly built dwellings declined 0.6 percent in December, the second straight monthly drop.

Stevens, in yesterday’s statement, characterized the outlook for the world economy as “strong going into 2011” and said the Chinese and Indian economies have recorded “very strong” expansions.

Employment Growth

He also said employment growth was “unusually strong” last year and “most leading indicators suggest further growth, though most likely at a slower pace.”

Employers added 2,300 jobs in December, capping the strongest year of job growth with the smallest monthly increase since February. The unemployment rate dropped to 5 percent in December, the lowest level since January 2009.

As floodwaters recede, builders may need to compete with resources companies for workers as investment in mines feeding Chinese industrial demand pulls down unemployment.

“The pick-up in mining investment will see the unemployment rate dip below 5 percent during the June quarter, leading to a 25 basis points rate rise before midyear,” said Paul Brennan, an economist at Citigroup Inc. in Sydney.

Australian Dollar

The Australian dollar has declined about 1.1 percent this year against its U.S. counterpart as investors expect the cleanup in Queensland, which accounts for about a fifth of the national economy and 80 percent of the country’s coking coal output, will discourage the central bank from rate increases.

The so-called Aussie traded near its highest in a month against the U.S. dollar today, fetching $1.0118 as of 4:48 p.m. in Sydney from $1.0111 in New York yesterday, when it touched $1.0149, the highest since Jan. 4.

Treasurer Wayne Swan said last week the inundation of Queensland and the southern state of Victoria is expected to add 0.25 percentage point to inflation this quarter and cut 0.5 point from gross domestic product.

Some economists estimate as much as A$20 billion ($20.2 billion) in repairs and rebuilding. The costs may jeopardize the government’s goal of a $3.1 billion surplus in the year ending June 30, 2013. Through the disaster, Prime Minister Julia Gillard has repeated a pledge to eliminate the deficit by that time.

Finding workers for the reconstruction in Queensland, as well as the flood-damaged Victoria and New South Wales states, may become increasingly difficult in an economy where the labor market is already stretched.

Two coal-seam gas projects, expected to cost more than A$30 billion, are proceeding near the Queensland port of Gladstone. Santos Ltd., Australia’s third-largest oil producer, and BG Group Plc, the U.K.’s third-biggest gas producer, will start hiring the first of more than 10,000 construction workers needed for the two projects later this year.

“After the significant decline in 2009, growth in wages picked up somewhat last year,” Stevens said in the statement. “Some further increase is likely over the coming year.”

To contact the reporter for this story: Michael Heath in Sydney at heath1@bloomberg.net;

To contact the editor responsible for this story: Stephanie Phang in Singapore at sphang@bloomberg.net

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