RBA Slashed Rates to Combat Grim Global Outlook

Australia's central bank slashed interest rates this month because turmoil in  financial markets threatened the outlook for the global economy and warranted a "significantly less restrictive stance of monetary policy", minutes of its October policy meeting showed on Tuesday.

The policy board of the Reserve Bank of Australia (RBA) also noted that the high level of interest rates  meant that monetary policy had significant capacity to provide stimulus, though it cautioned against expecting another cut of the size of October's dramatic 100 basis-point easing in the cash rate to 6.0 percent. That was the biggest cut in 16 years and twice what analysts had expected.

"The key factors for members' consideration were the sharply worsening conditions in financial markets in  September and the consequent deterioration in the global economic outlook," the minutes showed.

Falling asset values and a steep slowdown in credit growth across the world meant that activity in the  major economies would slow even further. 

This bleaker outlook for world growth and heavy falls in commodity prices meant it was more likely that Australian firms, notably miners, would scale back on previously ambitious investment plans.

The drop in commodity prices would also erode any stimulus from the Australia's terms of trade - what it  gets for exports compared to what it pays for imports.

RBA Governor Glenn Stevens also felt the unusually large cut was necessary because the global credit  squeeze had pushed up commercial banks' funding costs by about 20 to 25 basis points.

"Any reduction in interest rates that banks announced on loans to customers would most likely be less than  the change in the cash rate," the minutes showed.

The board noted that consumer price inflation likely accelerated to around 5.0 percent in the third  quarter, well above the RBA's 2 to 3 percent target, but it was expected to decline in 2009. The inflation  report for the third quarter is due on Wednesday.

"Moreover, the recent deterioration in global growth prospects, together with the more difficult market  conditions even for credit-worthy borrowers, increased the risk that demand and output could be significantly weaker than earlier expected," the minutes showed.

"In that scenario, inflation would most likely fall faster than expected previously."

Indeed, given the falls in commodity prices, notably oil, it was likely that headline consumer price  inflation had probably peaked in most countries.

The board considered the possibility that a larger-than-expected cut in the cash rate would impact  negatively on market sentiment, and on the Australian dollar in particular given it had already fallen  sharply.

"Members concluded that, despite the possibility of a short-term adverse reaction, the stronger action  would help sentiment over time," the minutes showed.

Taking all these considerations into account, the board decided to cut by a full percentage point, twice  what the financial markets had expected.

"Members did not regard this unusually large adjustment as establishing a pattern for future monetary  policy decisions," concluded the minutes. 

Copyright 2008 Reuters. Click for restrictions.