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Worries about the European crisis led RBA to cut rates

Tuesday 20th December 2011

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Concern about the impact the European debt crisis could have on the Australian economy caused the Reserve Bank of Australia (RBA) to cut interest rates earlier this month.

“Developments in Europe continued to pose downside risks to the global economy and, consequently, also to Australia,” said the minutes of the RBA meeting which decided to cut the cash rate to 4.25 percent from 4.5 percent effective Dec. 7.

It was the RBA's second rate cut in a month, it having cut the rate from 4.75 percent on Nov. 4 after holding steady for a year.

The news on Europe was notably weaker and it remained unclear as to how the crisis would be resolved, the minutes said. “It seemed highly likely that the sovereign credit and banking problems would weigh heavily on economic activity there over the period ahead and there was a non-trivial possibility of a very sharp contraction,” they said.

“Overall, members concluded that growth in the world economy was likely to weaken over the coming year.”

The RBA said US economic data had improved but China's growth had been slowing, as policymakers intended, as had other economies in Asia, although Asian growth rates remained solid.

Some recent Australian domestic data had been more positive but conditions varied across sectors, investment picking up very strongly, household and business confidence improving although consumers remained cautious and the unemployment rate was broadly steady at a little above 5 percent.

“The financial side of the economy remained relatively subdued with soft credit growth and declining asset prices,” the RBA's minutes said.

Scott Haslem at UBS Economics said the RBA “appears to be in a wait and see mode as far as the need for further rate cuts.”

Haslem said he expects the subsequent deterioration in European financial markets after the latest cut and some recent weaker Australian data will likely lead the RBA to cut the cash rate further to 4% when it next meets in February.

“Thereafter, much depends on how much the world looks to be weakening and the impact of recent events on domestic business and consumer confidence,” Haslem said.

Annette Beacher at TD Securities said in her view not enough of the RBA board discussion was devoted to the much improved inflation outlook.

“Inflation pressures at present are very much skewed to the downside,” and underlying inflation, currently 2.5 percent, is likely to fall below the RBA's 2 percent to 3 percent target band in 2012, Beacher said.

She is forecasting a further 75 basis points of easing which would take the cash rate to 3.5 percent.

The RBA minutes expressed “the expectation that inflation would be consistent with the target over the next couple of years.”

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