RBA's Lowe says Australia likely to avoid unconventional policy

[SYDNEY] Reserve Bank of Australia Governor Philip Lowe said it was unlikely the central bank would resort to unconventional measures and that a flexible inflation target that took account of financial imbalances was the most appropriate way to decide policy.

Mr Lowe said the Australian economy was "not at all" running out of options and there was a strong case for infrastructure spending to support growth, in reply to questions on the limits of monetary policy from a parliamentary committee in Sydney Thursday.

The central bank, which has cut the benchmark to a record low 1.5 per cent, has previously indicated that rates become less effective at about one per cent.

"I think it's very unlikely we're going to, because of the path we're on, very unlikely we will be in a situation where we confront highly unconventional monetary policy," said Mr Lowe.

"But we do have options, as other countries have options."

The governor reinforced the flexibility of the RBA's two-three per cent inflation target and said his colleagues hadn't been "nutters" when it came to meeting the goal, while reiterating the importance of elevating financial stability in policy making.

The bank doesn't see its job as always keeping inflation "tightly in a narrow range" and a degree of variability in inflation "from year to year is both inevitable and appropriate".

Mr Lowe's remarks provided an upbeat assessment of the economy he inherited this week: while interest rates and wage growth are at record lows, reflecting anemic inflation, growth is above average and unemployment has fallen to a three-year low.

The central bank has lowered borrowing costs twice in the past four months to try to cap a currency supported by negative rates and bond-buying programs from Europe to Japan and a Federal Reserve hesitant to tighten.

"While these actions have generally not been taken with the direct intention of influencing exchange rates, they have, inevitably, affected international capital flows and exchange rates," Mr Lowe told the House Economics Committee.

"We have seen the effects here in Australia. The monetary expansion elsewhere and the low rates on offer overseas have meant that foreign investors have found Australian assets, with their relatively higher returns, attractive. In this way, what is happening elsewhere affects us here in Australia."

The Australian dollar has climbed more than 10 per cent since a mid-January trough, hampering the economy's transition to growth driven by services as a mining investment boom unwinds.

The key education and tourism industries are hyper-sensitive to the currency and had received a tailwind from a more than 25 per cent depreciation since the start of 2013.

"A lower exchange rate would be helpful," Mr Lowe said in response to a question.

"But of course we all can't have one."

The recent rise in the Aussie partly reflects higher commodity prices and the yield on offer in Australia, he said.

Fed Chair Janet Yellen overnight resisted pressure from within and without to tighten policy, saying the US economy has a little more room to run.

While she signaled rates will rise this year, the central bank scaled back the number of rises it expects next year to two from three.

A day earlier, Bank of Japan Governor Haruhiko Kuroda adopted a pledge of "overshooting" its two per cent inflation target and unveiled a strategy of targeting short- and longer-term rates to provide the economy with cheap borrowing costs.

Mr Lowe noted in that both the US and Japan cases, "policy remains highly accommodative".

Australia's economy is enjoying an unexpected fillip from a 30 per cent jump in the price of commodity exports compared with their trough earlier in the year as Chinese high-cost producers cut output of bulk commodities.

That prompted a turnaround in the terms of trade, or the ratio of export prices to import prices, that is a key determinant of national income.

Commodity prices had slumped in recent years as weaker Chinese demand for metals like iron ore to build bridges and skyscrapers combined with increased supply.

"While it is difficult to predict the future, if these increases were to be sustained then we could look forward to the drag on national income from falling commodity prices coming to an end," said Mr Lowe.

The RBA's rate cuts have spurred the housing markets in Sydney and Melbourne, leading some observers to warn of bubble-like conditions.

Mr Lowe said the outlook is improving following regulatory measures to curb lending to investors and as new stock comes in line.

"The construction cycle has a bit more momentum than we expected earlier," he said.

"Credit growth and turnover in the housing market are also lower than they were a year ago. Under APRA's guidance, lending standards have also been tightened. Overall, then, the situation is somewhat more comfortable than it was a year ago, although we continue to watch things carefully."

Traders are pricing in little chance of the RBA raising rates this year, just over 25 per cent in December, though bets rise to around 50 per cent by the middle of next year.

BLOOMBERG