IMF clouds Australia election with inflation warning

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CANBERRA, Oct 18 (Reuters) The International Monetary Fund has been pitched into the middle of Australia's big-spending election race after it urged the government to exercise restraint to keep a cap on inflation.

Conservative Prime Minister John Howard, lagging far behind Labor's Kevin Rudd in polls ahead of the November 24 election, on Monday offered 34 billion Australian dollar (30 billion dollar) in tax cuts in a bid to avert what opinion surveys say is near-certain defeat.

But the IMF in its latest world economic outlook said prudent financial policies and flexible exchange rates had helped underpin growth in New Zealand and Australia, where economic expansion is tipped to hit 4.25 per cent in 2007-08.

''Against this background, it is important that both governments continue to exercise fiscal restraint in the period ahead,'' the IMF said.

''The main short-term policy challenge ... continues to be to keep firm control on inflation in the face of strong domestic demand and tight labour markets.'' The pre-election warning struck at the key economic plank on which conservative hopes rest, with Howard this week asking voters to recall his strong economic record and saying interest rates would always be higher under a Labor government.

''The IMF is implicitly saying the economy doesn't need any additional stimulus and that interest rates are going to remain relatively high,'' ANZ Bank Chief Economist Saul Eslake said.

Rudd said he had read the IMF report and was keeping a tight rein on Labor's spending promises, wary of fuelling inflation.

''I will not be matching Mr Howard dollar for dollar for every promise he makes,'' he told reporters.

Howard, 68, is fighting to overturn a mood among voters for change despite the country enjoying a 10-year economic boom that has pushed unemployment to 33-year lows.

His government has delivered successive budgets in surplus and slashed taxes by 110 billion Australian dollar (100 billion dollar).

But his promise of continued prosperity and more jobs has been blunted by successive interest rate rises to 6.5 per cent, hurting bedrock conservative support in outer city suburbs, where home affordability and interest rates are major issues.

Housing affordability dropped to record lows in September, with the Commonwealth Bank and Housing Industry Association's index of affordability down by 2.1 per cent to 94.9 today, its lowest since the series began in 1984.

Markets are pricing about a 50:50 chance of another rate rise to 6.75 per cent in November, and see such a move as a certainty by March next year.

Howard and Treasurer Peter Costello, outlining their tax package, said lower income taxes would create 65,000 jobs and would be delivered in stages to avoid overheating the economy.

Costello said the IMF's prediction of GDP expanding by 4.4 per cent in 2007 and moderating to 3.8 per cent in 2008 outstripped growth predictions for either Japan or the United States.

''The IMF expects the unemployment rate to remain low in 2007 and 2008, at 4.4 per cent and 4.3 per cent respectively, and expects inflation to remain within the Reserve Bank of Australia's target band (of 2-3 per cent),'' Costello said.

He defended the tax cut plan, saying: ''It's one of the most critical areas of economic policy and it's a plan over five years to build the Australian economy stronger.'' The IMF's forecasts were in line with Australia's mid-year fiscal outlook handed down this week with a greater-than-expected 2007-08 budget surplus of 14.8 billion Australian dollar, up 4.8 billion dollar.

Costello has promised a re-elected conservative government would deliver surpluses of 1 per cent of GDP, making the 34 billion Australian dollar tax package affordable.

Both major parties have made almost 37 billion Australian dollar in election pledges since the six-week election race began on Sunday, with the government's tax package accounting for most.

Rudd has promised 2.5 billion Australian dollar for roads in marginal electorates.

Australia posted annual economic growth of 4.3 per cent in the second quarter, while the annual CPI was up 2.1 per cent.

Reuters AE DB0958

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