Australia's rate cuts coming to close on inflation fears

Australia's record round of interest rate cuts may be close to an end as central bank Governor Glenn Stevens focuses on the threat of inflation caused by surging government spending and borrowing costs at a 49-year low.

Much of the effect on the economy of six interest rate cuts and almost A$90 billion ($114 billion) in government spending on infrastructure, bond-market guarantees and cash handouts to consumers since September are "yet to be observed", Stevens said on Tuesday, when he kept the benchmark rate at 3 per cent.

While Australia has fallen into its first recession in two decades, Stevens signalled that he expects the stimulus, lower rates and a pickup in China to boost demand. A report two weeks ago showed core inflation held above the central bank's target range of between 2 per cent and 3 per cent in the first quarter.

"For the longer-term sustainability of a recovery, it's all about inflation," said Adam Carr, senior economist at ICAP Australia in Sydney. "And the best way to keep inflation in check is to withdraw stimulus before the recovery takes hold, at the first signs of stabilisation, which is what we've got."

The Australian dollar tumbled in the three months through March for a third straight quarter.

The weaker currency is keeping upward pressure on the cost of imported goods and services such as petrol and cars, even though the economy is probably in its first recession since 1991.

Australia's weighted median index, a gauge of core inflation published by the Reserve Bank of Australia on April 22, showed prices rose 4.4 per cent in the first quarter from a year earlier.

Unlike counterparts in the US, Canada and New Zealand, who have signalled that borrowing costs will remain low for some time, Stevens made no specific reference to the timing of any future rate moves.

By contrast, New Zealand central bank Governor Alan Bollard said last week that he won't raise borrowing costs before late in 2010.

Bank of Canada Governor Mark Carney said on April 28 he intends to keep his main interest rate at a record-low 0.25 per cent until the end of June 2010.

- BLOOMBERG