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Australia Business Conditions Toughest in 7 Years

A key measure of Australian business conditions hit its lowest level in seven years in July as firms reported falling sales and profitability, adding to the case for an urgent cut in official interest rates.

The National Australia Bank's (NAB) index of overall business conditions shed 5 points in July to -5, the worst monthly outcome since October 2001. Tuesday's survey also showed business confidence stayed at a lowly -9 points in July.

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"The key message is that the sharp slowdown in domestic demand continued through July and, more importantly, that the rate of slowing has accelerated," said Alan Oster, group chief economist at NAB.

Tighter financial conditions and weakening demand weighed heavily on retailing & personal services sectors, manufacturing and wholesaling. Even the red-hot mining sector reported some softening.

The broad-based deterioration in business conditions should reinforce the Reserve Bank of Australia's (RBA) belief that the economy is slowing enough to curb inflation over time, and thus support the case for a rate cut as early as September.

Investors are fully priced for a cut of 25 basis points in the 7.25 percent cash rate, and the scale of angst in the NAB business survey could add to pressure for a 50 basis-point move.

"Unless the RBA successfully loosens the policy stance and does so quickly, 2009 could well develop into a very hard landing," said Oster.

He now looks for at least 50 basis points of easing by year-end and for the cash rate to be down at 6 percent by the middle of next year.

Oster noted that large falls in sales and profits had begun to take a toll on labour hiring and led to a significant easing in capacity utilisation. The employment index dropped 3 points to -5, pointing to a coming slowdown in what has been one of the strongest parts of the economy.

The survey's measures of sales eased to -2 points in July, from 1 point in June, while profitability dived by 10 points to -9. Profit margins were squeezed by poor demand on one side and rising costs on the other.

The survey's measure of purchasing costs showed annual growth of 6 percent, up sharply from last year's lows at 3.25 percent, driven largely by energy and utility prices.

Meanwhile, capacity utilisation dropped to 81.6 percent, from 82.5 percent in June, and, in a worrying development, firms were also winding back investment plans.

"The view of business that the process is far from finished is somewhat concerning, with forward orders still slipping and confidence remaining at low levels," said Oster.

The index of forward orders dropped 3 points to -6 points, led by weakness in retailing and transport.