The Reserve Bank Governor, Glenn Stevens, says he supports the Federal Government's guarantee of bank deposits, but more work might be needed to iron out the plan's details.

Speaking in Sydney today, Mr Stevens also called for a renewed focus on productivity in the real economy, which has fallen away in the past five years as financial engineering has grown.

The Rudd Government's bank guarantee has imperilled the local operations of some non-Australian banks and money-market funds that do not enjoy the benefit of the guarantee.  (See Michael West's latest report here.)

Reports have indicated the Government may set an upper limit on deposit funds that it is prepared to guarantee.

"The Australian Government has announced a general guarantee of deposits as a precaution to allay any public anxiety over security of their savings," the RBA governor said in a lunch-time address in Sydney, according to a copy of his planned speech.

"Steps in these directions, in the context of what other countries were doing, were sensible and the RBA supported them,'' Mr Stevens said.

Swan's view

Treasurer Wayne Swan said Mr Stevens' comments supported the Government's position.

He denied a report in the Australian newspaper today that the Government had ignored the RBA's concerns about the impact of an unlimited guarantee scheme for all Australian deposit-taking institutions from October 12.

''When the Government took its decision on the guarantee for bank deposits, it took it with the full support of the Reserve Bank,'' Mr Swan told reporters in Canberra. ``The comment that there was a refusal to heed that advice from the RBA about the taking of that decision is absolutely untrue.''

Mr Stevens noted in his speech that bank guarantees remain a work in progress at home and abroad.

"As is also the case in other countries, the design features of the various guarantees will be important. Little detail is available from other countries yet,'' he said.

"Meanwhile, the RBA is working with our colleagues in the Treasury on the details of the Australian arrangements, including on how to maintain continued healthy functioning of Australia's short-term money markets.

New role for finance

Mr Stevens also said the role of finance in the economy might have to change.

"Perhaps we will need also to get better at turning borrowing for housing into more dwellings rather than just higher house prices,'' he said.

"Perhaps the finance sector globally will return to fulfilling something more like its historical role of being 'the handmaiden of industry', with a bit less in the way of exotic innovation of its own.''

"In such a world, a renewed focus on the processes in the real economy which generate growth in productivity could also be apt.

"In the case of Australia at least, it is now hard to avoid the conclusion that underlying growth in productivity has slowed over the past five years, compared with what was seen through most of the 1990s and the early part of this decade.

`Catastrophe' risks recedes

Meanwhile, Mr Stevens said the threat of a ``global catastrophe'' have declined in recent weeks as policy makers around the world work to restore liquidity and confidence in the financial system.

''At moments like this, it's hazardous to make predictions,'' Stevens said. ''However, it seems to me that the key elements of dealing with the root issues in the crisis are starting to come into place.''

The turmoil prompted Stevens to unexpectedly slash Australia's benchmark rate this month by 1 percentage point to 6%, the biggest reduction since a recession in 1992.

Investors are now betting that the RBA will cut rates by another half a percentage point to 5.5% when the board next meets on November 4th.

As a result of the coordinated efforts worldwide, ''the likelihood of a global catastrophe has declined over the past couple of weeks,'' he said.

Markets

Australia's dollar traded at 69.91 US cents from 69.81 cents before Stevens' comments were released. The two-year government bond yield rose 7 basis points, or 0.07 percentage point, to 4.29%.

Stocks also held on to morning gains, with the main share indexes trading recently about 2.9% higher for the day.

Stevens said his decision to cut borrowing costs on Oct. 7 was taken even though inflation in Australia is ''likely to remain high in the period immediately ahead.''

''Looking forward to next year, forces seem now to be building that will start to dampen pressures on prices, even though we won't have evidence for that for a good six months,'' he said.

Members of the bank's board said in minutes of their October meeting, published today, that increased risks to Australia's economy provided a ''strong economic case'' for the larger-than-expected rate reduction.

Inflation report

Annual inflation probably accelerated in the third quarter to 4.8% from 4.5% in the previous three months, according to the median estimate of 16 economists surveyed by Bloomberg News. The prices report will be released tomorrow at 11:30 a.m. in Sydney.

Policy makers, who aim to keep price gains between 2% and 3% on average, seek ''to respond to the medium-term outlook for prices, not just the current data,'' Stevens said today.

The Australian dollar's 21% decline against the US currency this year ''also amounts to a significant change for the trade-exposed sectors of the economy, though at the cost of some temporarily higher price rises,'' the Governor said.

''These changes will act to lessen the extent of the likely slowdown in Australia's economy, even as global forces work the other way.''

China, Australia's largest trading partner, will ''probably grow pretty strongly, on average, over many years,'' though it is slowing now, Stevens added.

Sydney Morning Herald, with Bloomberg, AAP