Inflation limits rate cut scope - RBA

AHEAD of next week's interest rate announcement a top RBA policymaker says high inflation will limit the scope for rate cuts.

Inflation limits rate cut scope - RBA

A TOP Reserve Bank of Australia (RBA) policymaker says high inflation will limit the scope for future interest rate cuts.

Economists surveyed by AAP expect the RBA to cut rates by a bigger than usual 50 basis points on Melbourne Cup day (next Tuesday), which would take the cash rate to 5.5 per cent for the first time since May 2006.

But RBA deputy governor Ric Battellino said high inflation would make it harder to keep cutting rates to stimulate the economy amid a global slowdown.

"Australia managed to sidestep the 2001 global recession. Can it do it again?,'' he said at the Insolvency and Trustee Service Australia bankruptcy congress in Sydney today.

"We also have to recognise that the task of managing the economy this time will be more difficult than in 2001 because we are starting with a bigger inflation overhang.

"The (Reserve) Bank has for some time thought that inflation would peak in the second half of 2008 and then fall; accordingly, we have acted pre-emptively in reducing interest rates.

"Nonetheless, there is still a big task ahead to bring inflation down and this could limit room for manoeuvre on monetary policy.''

ANZ economist Riki Polygenis said Mr Battellino was trying to talk down short-term market expectations for large interest rate cuts.

"Today's speech by RBA deputy governor Battellino contained three key messages: Australia's economic outlook is very uncertain; inflation is still important and may limit the RBA's ability to cut rates and; Australia's house prices are not as dire as in the US,'' she said.

Headline inflation in the year to September surged by 5 per cent, its fastest pace since late 1995 when the effect of the introduction of the goods and services tax in 2000 was excluded.

Several economists surveyed by AAP expected interest rates to fall to 4.25 per cent by mid 2009, where they were in late 2001 following the September 11 terrorist attacks in the US.

Australia's cash rate has not fallen below that level since the RBA began publishing a target interest rate in 1990.

The RBA does not expect inflation to fall back to the top of the 2 to 3 per cent target until mid 2010.

Mr Battellino also said real income would grow at a slower pace compared with the period before the onset of the credit crunch.

"I think it is now widely accepted that growth in real incomes over the next year or two will be more subdued than over the past five years,'' he said.

The deputy RBA chief said the Australian economy was likely to grow at a slower pace in the next two years.

"The next couple of years will be noticeably more subdued that the past five,'' he said.

CommSec chief economist Craig James praised Mr Battellino for pointing our that unlike the US, Australian house prices were unlikely to suffer sharp falls because the domestic market had an undersupply of housing.

"The Reserve Bank has provided some balance into the economic debate, something that has been sadly lacking in recent times,'' Mr James said.

"Clearly the views of the more gloomy commentators should have been challenged.

"The facts and figures provided by the Reserve Bank are freely available but unfortunately they have not had the same degree of exposure.''

University of Western Sydney associate professor of economics and finance Steve Keen has predicted a 40 per cent drop in Australian house prices.

Without mentioning Dr Keen by name, Mr Battellino gently chided commentators who had been talking down the economy.

"To top it off, some commentators are predicting sharp falls in house prices here in Australia,'' Mr Battellino said.

"Given the daily barrage of gloom and doom, it is easy for households to lose perspective, so I thought it would be useful to take an objective look at the state of household finances.''