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RBA cuts core inflation forecast, unlikely to hit target this year

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Australia's central bank forecast core inflation is unlikely to reach the bottom of its target this year and will probably only do so in the ensuing two years as the developed world's disinflation quandary spreads.

[SYDNEY] Australia's central bank forecast core inflation is unlikely to reach the bottom of its target this year and will probably only do so in the ensuing two years as the developed-world disinflation quandary emerges Down Under.

The central bank, in its quarterly statement Friday, left estimated economic growth at 2.5 per cent to 3.5 per cent this year and next and predicted unemployment will remain around the current 5.7 per cent. It gave no guidance on the interest-rate outlook after cutting to a fresh record of 1.75 per cent this week.

"The phenomenon of surprisingly low wage growth for given labour market conditions has been apparent across a number of advanced economies," the Reserve Bank of Australia said.

"Furthermore, the recent inflation data indicate that the weakness in domestic cost pressures is not only evident in low growth of nominal wages but is more broadly based."

Australia's recession-level wage growth - partly explained by mining workers moving from higher to lower paid jobs - is likely to persist longer than previously forecast, compressing inflation.

Outside consumer prices, Australia's economy has appeared in good shape: unemployment is at a 2 1/2-year low, business conditions and confidence are strong and the key iron ore price has rebounded almost 40 per cent this year.

Australia's resource industries have benefited from policy easing in China, where the central bank has held the main rate at a record low since October.

While that has shown signs of gaining traction, with an across-the-board rebound in China's March data, it has also been accompanied by an increase in debt to 2.5 times the size of the economy and soaring home prices.

The RBA said China's authorities appear to be prioritizing short-term growth over "deleveraging and achieving growth that is less reliant on investment and heavy industry" in the longer-term. It said the outlook for China's economy is a "key source of uncertainty." Australia is the developed world's most China-dependent economy.

"One risk is that the pursuit of the authorities' near- term growth targets is likely to increase already elevated levels of debt and could potentially delay addressing the problem of excess capacity in the manufacturing and resources sectors," the RBA said in its Statement on Monetary Policy.

The RBA has also faced difficulties with the currency, which appreciated as much as 15 per cent this year and threatened its efforts to rebalance the economy toward sectors like tourism and education and away from mining.

These industries are among the most sensitive to the exchange rate and services exports had switched to contributing to growth from detracting from it.

The central bank noted a 10 per cent appreciation in the Aussie reduces the level of gross domestic product by between 0.5 per cent and 1.5 per cent "generally within two years."

Australia's inflation shock emerged last month when deflation was recorded in the consumer price index for the first time since 2008 and annual core consumer-price growth slowed to the weakest on record. In response, the RBA cut rates by a quarter-point on Tuesday, ending a one year pause.

"The board will continue to assess the outlook and adjust policy as needed to foster sustainable growth in demand and inflation outcomes consistent with the inflation target over time," the central bank said, referring to its aim of consumer- price growth of between 2 per cent and 3 per cent on average.

On the positive side, the RBA forecast household consumption would continue at an above-average pace even as wage growth remained weak, implying a further decline in the savings ratio. It also said the terms of trade, or the ratio of export prices to import prices, would be a bit higher in the near-term, though it didn't expect the rebound in iron ore prices to last.

The RBA is trying to orchestrate a transition away from mining investment to other industries in the economy, using low rates and a weaker dollar as a tailwind for industries. In some areas this is working: rising house prices have fueled a residential construction boom and conditions for business are above average.

Yet there is still no sign of an uptick in investment outside the mining industry it is seeking.

The central bank did say there remains a "substantial" amount of residential construction work in the pipeline, indicating further strong growth in dwelling investment.

BLOOMBERG