Australia Surprises with 75 Basis Point Rate Cut

Australia's central bank cut its benchmark cash rate by a bigger-than-expected 75 basis points on Tuesday, in an increasingly urgent effort to save the economy from the recession rapidly engulfing much of the developed world.

The Australian dollar slipped as rates were slashed to 5.25 percent, the lowest since March 2005, while the total easing of 2 percentage points in just two months was the most aggressive since the dark days of 1990/91.

Investors took the Reserve Bank of Australia's (RBA) surprising boldness as a sign that further cuts were coming and bill futures jumped to price in rates of 4.0 percent by mid-2009.

"We think the cash rate will bottom at 4 percent by early next year," said Stephen Halmarick, co-head market economics at Citi. "They are obviously very concerned about the outlook for global growth, I think that is warranted."

In a brief statement following its monthly policy meeting, the RBA said recent economic data pointed to a significant worsening in the global outlook, with China and emerging economies slowing as well.

Australia's easing follows cuts in the United states, China, India and Japan last week and comes ahead of likely reductions in the UK and euro zone on Thursday.

"A growing number of indicators have fallen off a cliff in October," said Rory Robertson, interest rate strategist at Macquarie. "Indeed, each of the big developed economies now is either in a severe recession or well on the way."

"The RBA must be worried about the growing risk of recession here and is trying to nip it in the bud," he added. "We see  central banks cutting aggressively, towards 4 percent in Australia and 2 percent in the UK and the Euro-zone."
     
Vital Time

In his post-meeting statement, RBA Governor Glenn Stevens said the grimmer global outlook coupled with falling prices for Australia's commodity exports meant it was likely that spending and activity at home would be weaker than previously expected.

The latest cut was lauded by Treasurer Wayne Swan. 

"This is the additional rate relief families and businesses need in the face of the global financial crisis," he told reporters. "It will strengthen our economy at a vital time."

The market crisis has been a destroyer of household wealth this year as equities crumbled. Even once resilient house prices suffered a record 1.8 percent drop in the third quarter.

October looked even worse, with the main Australian share index falling as much as 21 percent in the month. Manufacturers reported the biggest contraction in activity on record and retailers were wailing to anyone who would listen.

Still, analysts saw reason to hope Australia could escape the worst of the global downturn.

The dip in house prices so far was relatively modest as there was no massive hangover of unsold homes, unlike in the United States. If anything, home building has not kept up with record immigration in recent years leaving plenty of pent-up demand.

A slump in the Australian dollar -- it has fallen by a quarter in trade weighted terms since July -- was a big boost to exporters and to miners, who earn U.S. dollars for their output.

Policy makers also have plenty of firepower, with the government's budget in surplus and RBA rates still above the lows of 4.25 percent touched in the slowdown of 2001.

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The RBA's easing has brought mortgage rates down sharply, with Commonwealth Bank cutting its mortgage rate by a further 58 basis points on Tuesday. In contrast, U.S. home loan rates have hardly budged despite 100 basis points of Federal Reserve cuts.

And the Labor government has already announced a A$10.4 billion stimulus package, $8.7 billion of which will be hitting households just in time for Christmas.

"Even a cautious household sector will find room to spend some of the additional cash, and it doesn't take much to be spent for there to be a big boost to retail sales," said Matthew Hassan a senior economist at Westpac.

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