Sydney prices a barrier to rate cut

"Exuberant" house prices in Sydney are blocking plans to cut interest rates to prop up the national economy, Reserve Bank governor Glenn Stevens has revealed.

Speaking in New York yesterday, Mr Stevens said the Federal Government would have to let the Budget deficit grow this year and focus on ways to bring it under control in the longer term.

The bank surprised markets and disappointed mortgage holders this month when it decided against taking rates to a record low of 2 per cent.

Mr Stevens said the Reserve had "signalled a willingness" to trim interest rates should it help boost the overall economy.

The governor, who lives in Sydney, said prices in the nation's biggest city were an issue that had to be taken into account, even though there were other trends at play in the rest of the country.

"It is hard to escape the conclusion that Sydney prices - up by a third since 2012 - look rather exuberant," Mr Stevens told his international audience.

"While the conduct of monetary policy can't allow these financial considerations to dominate the 'real economy ones' completely, nor can it simply ignore them. A balance has to be found."

Mr Stevens said the sharp fall in iron ore prices was delivering a cut in Australia's national income.

That was flowing into Budget coffers, leaving the Government's plan to reduce the deficit in tatters.

Mr Stevens effectively gave Treasurer Joe Hockey the green light to let the deficit grow in the coming Budget, saying it would help support the economy.

"On the fiscal front, the Government has little choice but to accept the slower path of deficit reduction over the near term," Mr Stevens said. "But over the longer term, hard thinking still needs to occur."

The comments came after Chinese officials at the weekend slashed the amount of cash the nation's banks needed to hold in a bid to stimulate the economy of Australia's most important trading partner.