Petrol Good As Gold In West, Bad For Rest

Sydney Morning Herald

Saturday June 14, 2008

Jacob Saulwick

THE RESERVE Bank governor, Glenn Stevens, has left the door open for more interest rate rises this year, warning that the bank cannot rely on record petrol prices to slow the economy and cut inflation.

Mr Stevens stressed the need to maintain "tight monetary policy" - interest rates - while the economy was being boosted by a massive surge in commodity prices.

Speaking in front of a Melbourne business audience yesterday, the governor gave no signal he would be prepared to loosen interest rates any time soon.

He said that while the US economy was slowing, Australia's main trading partners in Asia had not been badly exposed to the subprime debacle - implying the commodities boom looked like continuing through the credit crisis.

Acknowledging that consumers were becoming more cautious, Mr Stevens highlighted the complicated effect record petrol prices had on the economy.

Higher petrol prices drive up inflation but should - "other things equal" - weaken the rest of the economy by acting as a brake on spending, he said, before adding: "But other things are not equal."

Instead, he said, fuel prices - which touched 169.9c a litre in Sydney this week - were part of a spike in commodities that was pumping money into the country and into the pockets of mining shareholders and people working in resources, construction and services to the mining industry.

In this context, interest rates needed to remain up "not only because inflation has already picked up, but ... to head off further problems that could easily emerge, given the expansionary effects of the terms of trade," he said. "This is why a tight monetary policy setting is essential. It is why the Reserve Bank has lifted interest rates, even as the Federal Reserve was reducing them."

Financial market economists were divided about what the speech to the American Chamber of Commerce in Australia signalled about interest rates.

The chief economist at nabCapital, Rob Henderson, said the speech was neutral in its outlook for interest rates.

Richard Grace, the chief currency strategist at the Commonwealth Bank, said the governor suggested "very sternly, that interest rates are going to remain high for a long time".

Mr Stevens said consumers would have to slow spending to make room for strong business investment, inspired by high resources prices that were "permanent enough feature of the landscape that we are adjusting to".

"In most economies, it is usually not possible, and certainly not prudent, to try to have a consumption boom at the same time as an investment boom," he said.