Published: Monday, 27 Jul 2009 | 11:38 PM ET

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Australia's top central banker on Tuesday said the economy had fared well enough that upside risks to the outlook now balanced out those on the downside, noting the danger that low interest rates could inflate home prices.

Rob Griffith / AP

Reserve Bank of Australia (RBA) Governor Glenn Stevens said a very real challenge ahead would be to ensure that low mortgage rates led to an increase in home construction and not just higher home prices.

"If we fail to do that...then it will be very disappointing, indeed quite disturbing," Stevens told a charity lunch.

Not only would it confirm serious supply-side impediments to producing affordable housing in Australia, "it would also pose elevated risks of problems of over-leverage and asset price deflation down the track", he added.

Stevens said the dangers of too much borrowing chasing up asset prices had been all too evident in other countries.

"These risks have been reasonably contained so far in Australia, but it would be prudent not to push our luck here," said Stevens.

He noted a significant increase in demand for home loans and that house prices were tending to rise, in marked contrast to many other developed nations.

That was one reason the Australian economy was weathering the global financial crisis better than many others.

"It appears at this stage, that the downturn we are having may turn out not to be one of the more serious ones of the post-War era," he said. "We can much more easily imagine upside risks to the outlook, to balance out the downside ones, than was the case six months ago."

Both business and consumer confidence had improved, aided by low interest rates and fiscal stimulus. The central bank cut its key cash rate by a massive 425 basis points between September and April, taking it to a record low of 3.0 percent.

The economy has since fared better than feared, leading financial markets to price out almost any chance of another easing. Instead, investors have been wagering the next move would be a tightening, possibly in the first quarter of 2010.

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Stevens said nothing directly on the outlook for interest rates in his speech, though his emphasis on upside risks for the economy could reinforce market expectations of tightening.

Stevens noted another challenge for Australia would be if global commodity prices remained at elevated levels, as was possible given demand from emerging economies like China.

In that case the mining and resource sectors of the Australian economy would likely expand further, while other sectors would tend to contract, leading to imbalances.

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"Moreover, if we are more integrated into China's expansion, we will be similarly more exposed to the consequences of whatever might go wrong in that country," he warned.

Looking abroad, Stevens said the extraordinary  measures many countries had taken to support household demand and their financial sectors would likely have to remain for some time yet.

But policy makers would have to remove such exceptional accommodation eventually, including any guarantees for bank funding, he said.

Indeed, he warned against a world where the bulk of debt was government issued or guaranteed, since that could make investors complacent and lead banks to take dangerous risks.

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