Australia’s central bank is relying on slower wage growth and better productivity to contain inflation pressures as the damping effects of a four-decade high currency begin to wane, Deputy Governor Philip Lowe said.
Prices (AUCPIYOY) of globally traded goods “are unlikely to continue to fall over the medium term, particularly as the effects of the exchange-rate appreciation dissipate,” Lowe said in the text of a speech today in Sydney. “As a result, some slowing in the rate of increase in the prices of non-tradables is likely to be required at some point for overall inflation to remain consistent with the mid-point of the target range.”
Australia’s currency has risen 4.8 percent this year and reached a six-month high of $1.0845 last week after the Reserve Bank of Australia unexpectedly kept its benchmark borrowing cost at 4.25 percent. In the past month, the local units of General Motors Co.’s and Toyota Motor Corp. (7203) said 450 people will be fired as the strong local dollar erodes overseas demand.
Lowe, who didn’t directly address monetary policy in his prepared remarks to the Committee for Economic Development of Australia, said the nation’s exchange rate is currently around its highest level since the early 1970s, when adjusted for inflation. As a result, he said, the prices Australians are paying for manufactured goods are similar to a decade ago even as household incomes have increased more than 60 percent over the same period.
The extended period of a strong currency is having a contractionary effect on parts of the economy, hurting the nation’s manufacturing, tourism and education industries as well as some parts of agriculture and some business services.
“In some cases, this is prompting renewed investment to improve firms’ international competitiveness,” Lowe said in the speech, his first as deputy governor. “But in other cases, businesses are scaling back their operations in Australia and some are closing down. These changes are obviously very difficult for the firms and individuals involved.”
The flipside of these difficulties is an expected “double- digit” increase in business investment over the next couple of years as the nation’s mining boom intensifies. The windfall would boost investment as a share of the economy to a “record level by a considerable margin,” Lowe said.
Lowe said the resource bonanza and high local dollar were “historically very unusual” and complicated the process of assessing the economy. “It seems, however, that over the past year these forces have balanced out reasonably evenly,” Lowe said.
The RBA expects core inflation will remain within its 2 percent to 3 percent target range for the next couple of years and the economy to expand at around trend, Lowe said.
He contrasted Australia’s economy starting the year “in relatively good shape” with Europe and the U.S. having to cut budget deficits simultaneously to cope with their debt. He reiterated the RBA’s view that “progress has been made” in Europe’s efforts to stabilize its sovereign-debt crisis.
“Late last year there was a palpable sense that something might go badly wrong over our summer,” Lowe said. “Clearly, that has not happened.”
The RBA cut its benchmark interest rate by a quarter percentage point at back-to-back meetings last quarter as Europe’s fiscal problems deepened. It unexpectedly kept borrowing costs unchanged last week as the euro area showed signs of improvement.
Lowe also noted that the U.S. has emerged from a soft patch in the middle of last year with some momentum, citing the better than expected labor market and “tentative signs” of improvement in the housing market of the world’s biggest economy.
In Australia, “growth has been around trend and inflation is consistent with the target, and there are reasonable prospects for this to continue,” Lowe said. “We also have much more flexibility to deal with unfolding events than almost any other developed economy.”
Traders are betting there is a 50-50 chance the RBA will lower borrowing costs by a quarter percentage point next month, interbank cash-rate futures showed today.
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