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High commodity prices tipped to stay

April 2, 2008 at 16:15 by Mario

The spike in commodities prices driving the Australian economy is likely to be higher for longer, increasing the difficulty of reining in inflation, a senior Treasury official predicts.
The head of Treasury’s macroeconomic group, David Gruen, said in Sydney yesterday that the budget would seek to play a role in coping with the inflationary effect of a once-in-50-year surge in export prices.
Dr Gruen said the effect of higher interest rates on the heavily indebted was even more potent now than in previous periods of rising rates because of the growth in household borrowing.
“The ratio of household debt to annual disposable income is now around 160 per cent, up from around 100 per cent at the time of the 1999–2000 tightening, and around 65 per cent when interest rates were being raised in 1994,” he said.
Among the world’s richest countries, Australia has been the biggest beneficiary of fast growth in China and India. Figures released this week showed another surge in the prices of commodities exported from Australia, even beyond well-publicised jumps in coal and iron ore prices.
The Reserve Bank’s commodity price index for March rose 0.4 per cent in March, after a 4.7 per cent jump in February chiefly on the back of increases in prices for nickel, aluminium and copper.
Asked whether there was a risk that a number of investments in mining projects seeking to cash in on the rising commodity prices would leave Australia facing a “resources bubble”, Dr Gruen said that if China and India followed the path of smaller developing nations there “is a coherent story about why it might be that Australia’s resources prices might be higher for longer.”
With agriculture also expanding due to an increase in investment and recent rains, Dr Gruen said the rest of the economy would “need to grow quite slowly” to bring inflation back within its 2–3 per cent target range.
He said the Federal Government’s commitment to a budget surplus of at least 1.5 per cent of gross domestic product would seek to alleviate some of the pain caused by the need to slow the economy to combat inflation, and would “spread some of the adjustment more broadly across the economy.”
Dr Gruen, who has attended meetings of the Reserve’s board in place of the Treasury secretary, Ken Henry, also addressed concerns that high interest rates could tip the economy from boom to bust. He said that achieving a “soft landing” should not beyond the wit of policymakers.

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