Bank chief sounds inflation warning over mining boom

An expansion in Australia's economy, now in its 20th year of growth as a mining investment boom intensifies, will boost inflation pressures in coming years, central bank Deputy Governor Ric Battellino said on Friday.

"History tells us that inflation can be a problem during resources booms, and while there are grounds for thinking it will be less of a problem this time than in the past, we need to remain alert to the risks," Battellino said.

The Reserve Bank of Australia, which has led the Group of 20 nations in raising borrowing costs six times between October and May, kept interest rates unchanged on August 3 for a third month, partly on concern economic growth may slow in the United States and Europe.

Chinese demand for resources is prompting companies, such as Chevron, to boost investment, driving down unemployment and potentially worsening a shortage of skilled workers.

"Battellino is still bullish on the economy," said Joshua Williamson, an economist at Citigroup in Sydney.

"I agree with him that inflation is manageable right now, but will become an issue in 2011 as the economy accelerates," he said.

"It is reasonable to expect that further growth lies ahead," Battellino told a gathering of the Moreton Bay Regional Council.

"However, with the economy now operating close to its capacity, it will take further improvement in productivity and disciplined policies for this growth to be sustained."

The Australian dollar traded at US89.11c at 2pm on Friday from 89.09c just before the speech. The two-year government bond yield rose 1 basis point to 4.40 per cent. A basis point is 0.01 percentage point.

The central bank's rate increases have helped make the Australian dollar the third-best performing currency among the 16 most traded in the past year.

The local dollar has gained 40 per cent since March 2009.

"The exchange rate is at a relatively high level," Battellino said. "Still, given everything happening to the economy, I think it's a reasonable level. "But within that there are obviously going to be some industries that find it harder going with that exchange rate." Policy makers predict inflation will average 2.75 per cent until the end of next year, before accelerating to the top of the bank's 2 per cent to 3 per cent target range by mid-2012.

The RBA's measure of so-called core inflation, the trimmed mean, slowed to 2.7 per cent in the second quarter from an annual pace of 3 per cent in the first quarter, a report showed last month.

"We expect that it will stay around its current rate for the next year or so but, after that, upward pressure on inflation is again likely to emerge with a strongly growing economy," Battellino said.

To prevent inflation from accelerating, the central bank increased the overnight cash rate target by 150 basis points, or 1.5 percentage point, to 4.5 per cent in May from a half-century low of 3 per cent in early October.

Those moves have helped cool domestic demand as households cut spending and borrow less, according to recent reports.

Battellino said that policy makers are "very pleased" to have returned the level of borrowing costs paid by most consumers and businesses to "average levels".

Still, while Australia is "most likely" to do well over the next few years, "it would be a mistake to assume that the economic cycle has been eliminated", the deputy governor said.

Risks to the economy include the possibility that the global economy may lose momentum, "creating a significantly less favourable environment for Australia than is currently assumed", he said.

"Both the volume and price of our exports would be weaker and external financing might also be more difficult," he said.

"On the other hand, it could also turn out that inflationary pressures build more quickly than assumed."

Traders say there is no chance central bank Governor Glenn Stevens will resume increases to the benchmark overnight cash rate target until next year, according to Bloomberg calculations based on interbank futures on the Sydney Futures Exchange.

Battellino said a key driver of Australia's economy is likely to be an increase in business investment, particularly in the mining industry.

Mining investment "typically" runs at about 1.75 per cent of gross domestic product, and in previous mining booms has reached as much as 3 per cent of GDP, he said.

"In the current boom, it has already risen to 4.25 per cent and even on conservative assumptions, is expected to rise significantly in the years ahead."

Increased business spending will help drive down the jobless rate, which was 5.3 per cent last month, almost half the level of the US, according to the central bank.

"Household income will most likely rise quite solidly, which should underpin consumption even if households maintain their recent higher rate of savings," Battellino said.

- BLOOMBERG