Australia's central bank on Monday lowered its forecasts for economic growth for the next two years, saying it would be reviewing interest rates in the months ahead with the aim of avoiding an even sharper slowdown in domestic demand.
In its quarterly monetary-policy statement, the Reserve Bank of Australia (RBA) said the intensification of the global financial crisis meant the outlook for world growth was significantly weaker than previously assumed. Its new forecasts were even lower than the government's revised forecasts announced last week.
Falling share prices had also cut into household wealth at home, while a slump in commodity prices would hurt earnings from Australia's resource exports, the bank said.
As a result, the central bank had decided that a significantly more rapid easing in monetary policy was needed and it slashed the key cash rate by 200 basis points between September and November, taking it to a three-year low of 5.25 percent.
"In reviewing the stance of monetary policy each month in the period ahead, the board will be seeking to strike the appropriate balance between avoiding an unduly sharp weakening in demand and the need for inflation to fall back to the target over a reasonable period," wrote RBA Governor Glenn Stevens in an introduction to the 68-page report.
Investors are pricing in a further cut of at least 75 basis points when the RBA board meets next month and see rates reaching 4.25 percent or lower by March.
The RBA cut its forecast for economic growth in 2008 to 1.5 percent, from a previous 2.0 percent, and for 2009 to 1.75 percent from 2.5 percent. It saw growth picking up to 2.5 percent in 2010, but again that was down from 2.75 percent previously.
"Given the weakness in the global economy, prospects are that growth in domestic spending and activity will remain below trend for some time," wrote Stevens.
One drag on the economy would be the sharp drop in prices for Australia's commodity exports. "It is clear that Australia's terms of trade have now peaked, and movements in the terms of trade are likely to subtract noticeably from national income growth over the year ahead," said Stevens.
Yet the central bank also revised up its estimates of underlying inflation by around a quarter of a percentage point to reflect the boost to import prices from the steep fall in the Australian dollar in recent months.
It now sees core inflation slowing only gradually from the current 17-year high of 4.7 percent to reach 3.5 percent by the end of next year and 3 percent by the end of 2010. Inflation would only return to within its 2 to 3 percent target band in 2011, instead of 2010 as previously anticipated.
It noted the outlook for growth and inflation was especially uncertain right now. One potential threat to Australia was a more rapid unwinding of the resources boom, which could badly affect previously optimistic business spending plans.
"It appears likely that there will be a significant scaling-back of earlier investment plans, in view of the deteriorating world outlook and increased financial uncertainties," wrote Stevens.
It predicted business investment would fall gradually over the next two years, in part because firms were finding it harder to get credit.
On the other hand, there was a chance the global economy would respond to monetary and fiscal stimulus and rebound more quickly than expected, said the RBA. The fall in commodity prices might also prove overdone, it added.