The International Monetary Fund (IMF) says inflation risks in Australia are “clearly on the upside” and the Reserve Bank of Australia (RBA) should be quick to lift rates if economic growth does not slow as expected.
In a consultation paper following discussions with Australian authorities and a range of private sector institutions, the IMF said the economic outlook was more uncertain than usual because of large countervailing forces.
“In our view, the balance of risk to growth is tilted toward the upside, stemming from the recent jump in commodity prices, sizeable immigration flows, and the increase in state infrastructure spending,” it said in the consultation statement.
“These factors could offset the impact of weaker consumer and business confidence and support domestic demand.
“On inflation, the risks are clearly on the upside.
“Further increases in energy prices are in the pipeline and capacity constraints, especially in the mining and housing sectors, could push wage and CPI inflation higher than envisaged.”
However, it said a global slump could weaken export demand, and further international financial turmoil could tighten credit conditions and increase bank’s funding costs.
Farm output may not rebound from the drought as expected, it said.
Its baseline forecast is that real gross domestic product (GDP) will decline below trend for the next two years, easing domestic capacity constraints and returning consumer price index (CPI) inflation back within the target band over the next two to three years.
Still, with inflation risks on the upside, “the RBA should be prepared to tighten quickly if leading indicators suggest that domestic demand will not slow as expected or the outlook for inflation deteriorates”.
Annual inflation currently stands at 4.2 per cent, way above the RBA’s two to three per cent target.
The June quarter CPI is released on July 23.
The IMF backs the RBA’s inflation-targeting framework, saying that despite the pick-up in short-term inflation expectations, the absence to date of a notable acceleration in wage inflation demonstrates that the target has helped to anchor medium-term inflation expectations.
It also supports the federal government’s strategy in the latest budget to save the revenue windfall from the commodity boom and thereby allow “automatic stabilisers to support monetary policy”.
“Saving some of the revenue from the commodity price boom in three new funds will take pressure of monetary policy in the near term and enable increased infrastructure investment over the medium term,” it said.
“The reduction in public spending growth in the latest budget illustrates the government’s commitment to help reduce inflation.”
But it said with upside risk to inflation, more public spending restraint could be required, and that increased capital spending by the states highlights the importance of maintaining restraint at the commonwealth level.
In separate statement, federal Treasurer Wayne Swan welcomed the IMF analysis.
“The IMF’s statement is a strong endorsement of the Rudd government’s first budget and long-term reform agenda to build our economy’s productive capacity,” Mr swan said.
On the Australian dollar, the IMF said while the currency will fall back as the RBA reduces the cash rate once inflation moderates, a portion of the improvement in the terms of trade is likely to be permanent.
“The currency is expected to remain above its average for the last ten years,” it said.