RBA gets defensive on rate hikes in Perth

THE RBA has defended its recent interest rate rise, saying the "early, modest tightening" was a pre-emptive move to guard against future inflationary pressures.

Reserve Bank of Australia deputy governor Ric Battellino has defended rate hikes / File

THE central bank has defended its most recent interest rate rise, saying the "early, modest tightening" was a pre-emptive move to guard against future inflationary pressures.

Reserve Bank of Australia (RBA) deputy governor Ric Battellino says inflation is now "broadly in the middle of the target range".

But over the medium term, as economic growth picks up, inflationary pressures are "more likely to be upward than downward", he says.

"For this reason, the board of the Reserve Bank decided at its meeting earlier this month that it would be prudent to make an early, modest tightening to guard against such an outcome,'' Mr Battellino said in a speech on economic developments in Perth yesterday.

This was consistent with the bank's forward-looking approach to monetary policy which "on balance" had helped keep the economy on a sustainable path, he said.

The RBA raised the cash rate by 25 basis points to 4.75 per cent at its November board meeting.

Minutes from the meeting show the central bank made a pre-emptive upward rate move to counter the future threat of inflation.

Mr Battellino said it was understandable that spare capacity was limited as the Australian economy had now grown more or less without interruption for about 20 years.

"This means that the economy cannot grow much above its potential rate without causing a rise in inflation,'' he said in the speech.

"With a large amount of money continuing to flow into the country over the next couple of years as a result of the resources boom, the challenge will be to manage the economy in a way that keeps economic growth on a sustainable path, with inflation contained.

"This is what the bank is trying to do.''

The RBA expects the Australian economy will continue to grow at a "solid pace" over the next couple of years, with growth picking up to an "above trend rate".

Overall, the economy was "doing well," with the number of jobs continuing to increase while the unemployment was falling, Mr Battellino said.

He said the growth of the world economy over the past year had resulted in a significant lift in commodity prices, particularly iron ore and coal, which had risen in recent weeks.

However, he said it was difficult to predict how long the mining boom would last.

The increase in terms of trade had now surpassed the 2008 peak and added $25 billion to the Australian economy.

He said recent commodity price outcomes had caused the RBA to revise up its forecasts.

Both China and India were going through a phase of development which was very intensive in the use of steel - a phase he said had taken other countries up to 20 years to move through.

"It is likely that China, and more particularly India, will have strong demand for steel for quite some time yet,'' Mr Battellino said.

He said the household saving ratio had picked up from the low levels it fell to earlier this decade, but non-residential building remained weak.

While the bulk of adjustment had already occurred in the Australian commercial property market, finance for commercial property development remained "tight", he said.

Looking abroad, Mr Battellino said global economic growth for the year had been strong and 2010 figures were likely to show the world economy grew by about 4.75 per cent in 2010.

The US household sector was still in "very poor shape", while the US corporate sector was in "pretty good shape".

Government debt problems were most acute in Europe and the situation had "deteriorated noticeably" in recent weeks.

Asia, on the other hand, was a "bright spot" for the global economy, but inflation could become a significant policy issue in if growth remained strong, he said.