SYDNEY, Nov 5 (Reuters) - The head of Australia's central

bank said on Thursday the country was on the road to recovery and

that spare capacity in the economy would only last a 'little

while', highlighting the need to boost supply.

In a speech on managing the coming expansion, Reserve Bank of

Australia (RBA) Governor Glenn Stevens said more also needed to

be done to boost the supply of housing to meet a rapidly

expanding population, perhaps through reform of planning rules.

And he noted that while massive offshore investment in

Australian resource projects would boost economic growth in

coming years, it could also sharply widen the country's current

account deficit.

'On the best reading of all the available information, this

appears to have been one of the mildest downturns we have had,'

Stevens told an economics dinner. 'Furthermore, it is likely that

recovery is already under way.'

Earlier this week the central bank raised its key cash rate

25 basis points to 3.5 percent, the second hike in as many

months, saying it was prudent to wind back stimulus given the

surprising strength of the economy.

Stevens said there was still some uncertainty that the

recovery would become a fully fledged expansion.

'The conduct of macroeconomic policies in the near term must

grapple with that uncertainty, as it always must do,' he said.

Yet the focus of his speech was very much on the medium-term

challenges of prudently managing an economic expansion.

He noted that Australia was starting this upswing with less

spare capacity than in some previous ones.

'After a big recession, it usually takes some years for

well-above-trend growth in demand to use up the spare capacity

created by the recession,' said Stevens.

'This time that process will not take as long.'

What spare capacity there was would only last for a 'little

while' longer, so it was important to add to supply and

productivity, he said.

The same was also true for the supply of housing, as strong

population growth was adding to the demand for homes. Apartment

building was being constrained by a lack of credit, but Stevens

felt this would not last, given the depth of demand.

'The more persistent difficulties look like they may be in

the areas of land supply, zoning and approval,' he said.

Stevens also saw challenges from rising investment in

Australia's copious natural resources, like natural gas, coal and

iron ore. While it would add to growth at home, much of the

finance for these projects would come from abroad.

'That is to say, absent some offsetting changes elsewhere,

Australia's current account deficit could be considerably larger

for some years than the 4 to 5 per cent of GDP we have seen on

average for the past generation,' said Stevens.

He felt such a temporary widening in the deficit would

probably be sustainable and manageable 'provided it involved a

relatively modest amount of currency mismatch, and a rise in

investment as opposed to a reduction in saving'.

Indeed, investment funded by equity inflows might be the

prefered means of funding since it would share the risk of these

resource projects with foreign investors, said Stevens.

The expansion of resource exports could also make Australia

more dependent on demand in a few countries, notably China and

India, leaving it more vulnerable to events in those countries.

(Reporting by Wayne Cole; Editing by Mark Bendeich)

(If you have a query or comment on this story, send an email to news.feedback.asia@thomsonreuters.com) Keywords: AUSTRALIA ECONOMY/

(wayne.cole@reuters.com ; +61 2 9373 1813; Reuters Messaging: wayne.cole.reuters.com@reuters.net)

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