Australia central bank says inflationary pressures remain

Australia's central bank sees inflationary pressures remaining, although Australia's economy may have slowed more earlier thought in the first half of 2006, potentially with some moderating impact on the outlook for inflation, Reserve Bank of Australia governor Glenn Stevens said. Stevens, in an address to business economists here, said the question remains whether the slowing was driven mainly by lack of supply or lack of demand. "Only in the latter case would it mean that spare capacity in the economy will have been increased," Stevens said in first major speech since becoming the central bank's head last month. "If, on the other hand, there really has been more growth than the gross domestic product (GDP) accounts suggest - more in line with the rise in employment and the trend decline in unemployment - then capacity probably remains pretty tight." Stevens said if this is the case upward pressure on inflation remains a distinct possibility. He said after 15 years of more or less continuous expansion, the economy is fully employed, adding that high rates of resource utilisation affect the conduct of monetary policy. "We need to be more alert to the risk of inflation than in periods when the amount of spare capacity was much larger," Stevens said. He said measures of consumer price inflation, excluding volatile items such as gasoline prices, have picked up, with input costs having risen across a range of areas. "We have a tight labor market, and despite the steadiness recently of official measures of wages growth, there is still pressure on labor costs, including the kinds that do not show up in wage statistics," Stevens said. At the same time, he said, there are some puzzles in the picture painted by the various pieces of data on the Australian economy. Stevens said real GDP growth is estimated to have declined to about two pct over the year to June 2006, after having grown by just under three pct in the preceding year. He said growth in domestic demand has also moderated from its earlier heady pace, though it still seems to have been running at 3.5-4.0 pct which is probably a bit above the economy's sustainable capacity to increase production. Yet, he said, growth in employment has remained quite strong, and the rate of unemployment has, if anything, edged down over the past year. "This sort of unemployment result would normally suggest that output growth had been at or slightly above trend, which most people would these days put at 3 pct or a little above," he said. But, Stevens said recent data suggests falling productivity: "It appears that, for the moment, we are left with something of a puzzle. That means that, as usual, monetary policy is being made under conditions of uncertainty," he said. On the international outlook, Stevens said a slowing in the US economy is coinciding with a more positive picture in the euro area and Japan than has been over recent years. "Japan looks more and more like it is finally escaping the stagnation that followed the excesses of the late 1980's and early 1990's," he said. "China has continued to grow with remarkable strength. To the extent that these and other areas are able to generate growth in domestic demand, as opposed to simply being pulled along by the US, the world economy could be expected to continue growing pretty well during 2007, though most likely below the 2006 pace." Stevens said the consensus of forecasts at present seems to be that such an outcome is the most likely.