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RBA warns on rising inflation risks as Wall Street plunges into correction territory

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The pace of rising inflation around the world after years in the doldrums in the wake of the global financial crisis could have serious implications for the global economy, the Reserve Bank has warned.

Key points:

  • Reserve Bank sees the economy growing 3.25pc (in 2018 and 19)
  • RBA also see the unemployment rate falling to 5.25pc
  • Inflation is expected to increase to 2.25pc later this year
  • Official cash rate (1.5pc) not likely to rise any time soon

The central bank's comments came after Wall Street stocks plunged once again with investor fears a strengthening US economy and firming inflation could prompt as many as four interest rate rises this year.

"Financial market volatility has picked up in recent days, most notably in equity markets as market participants have begun to reassess the outlook for global inflation and the withdrawal of monetary accommodation," the RBA said in its quarterly statement on monetary policy, released today.

"An important consideration for the outlook is how far inflation picks up as the global economy strengthens.

"A larger-than-expected increase in inflation would have implications both for financial market pricing and exchange rates."

Inflation fears and the prospects for consecutive rate rises in the US saw the Dow Jones Industrial Average end 4.2 per cent or 1,033 points lower.

Both the Dow Jones and the benchmark S&P 500 indexes are now in technical correction territory, having fallen 10.2 per cent from their record highs on January 26.

With good economic news seen as "bad news" for equity markets, the RBA noted stronger-than-expected growth in advanced economies, including the United States — helped by Donald Trump's tax reform measures which include a lower corporate tax rate.

Mixed forecasts

In Australia, the Reserve Bank is upbeat on the local economy, with the labour market "particularly strong" and GDP growth expected to increase to around 3.25 per cent (in both 2018 and 2019).

The RBA predicted a lower unemployment rate of 5.25 per cent in 2018 and 2019, down from its previous forecast of 5.5 per cent in December last year.

However, inflation was forecast to remain uncomfortably low before reaching 2.25 per cent later this year.

Although that would still be at the lower end of the Reserve Bank's 2-3 per cent target band.

The RBA forecast wages growth to remain subdued and to only increase gradually.

A key factor, according to the RBA, was strong competition between retailers which was contributing to deflation in consumer goods and several other retail categories.

But on a positive note, the RBA said reports of labour shortages had become more common and that there were signs in some pockets of the economy of a pick-up in wages growth.

Weak household spending

The RBA also warned on weak household consumption despite a spending recovery in the December quarter of last year.

"Growth in household incomes has been slow for some time," Australia's central bank noted.

"If this were to persist, it would likely constrain consumption spending, particularly in the context of high levels of household debt."

Despite the outlook for rising interest rates in the US, Reserve Bank governor Philip Lowe said Australia was not obliged to "move in lockstep" with other central banks.

Speaking at a dinner in Sydney last night, Dr Lowe said the cash rate would not move from its record low 1.5 per cent any time soon, and that improving inflation and a stronger jobs market were critical factors for the RBA board to consider.

The statement said conditions in housing had eased in Sydney and Melbourne, with prices in more expensive suburbs having fallen in recent months.

Follow Peter Ryan on Twitter @peter_f_ryan

External Link: Peter Ryan: RBA's warning as Wall Street plunges into correction

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