02 May 2012

Australia slashes interest rates by 50 basis points to 3.75% on slowing economy, Morgan Stanley Chief Economist expects more rate cuts to counteract fiscal tightening and still high Australian dollar

Australia's slowing economy was given a shot in the arm Tuesday when the central bank cut a hefty half-percentage point from official interest rates, signaling a shift in its focus away from fighting inflation and toward safeguarding growth amid an uncertain global outlook.

"Growth in the world economy slowed in the second half of 2011, and is likely to continue at a below-trend pace this year," said Glenn Stevens, governor of the Reserve Bank of Australia, in a statement following the decision to lower the official cash rate to 3.75%, its lowest since early 2010. "Growth in China has moderated, as was intended, and is likely to remain at a more measured and sustainable pace in the future."

Australia's economy depends greatly on resource exports to China, the country's largest trading partner. In the first quarter, China's economy grew 8.1%, its slowest rate in three years.

Mr. Stevens said that inflation, which was spurred last year by the mining boom and a series of natural disasters that pushed up food prices, has eased to a lower-than-expected level and is likely to remain within the bank's target range of 2% to 3% for the next two years. That gives the RBA scope to focus on helping segments of the economy, such as real estate and manufacturing, that have suffered from higher interest rates and the persistent strength of the Australian dollar even as the mining industry has prospered.

Demand for Australia's iron ore, coal and natural gas, mostly from Asia, pushed up the dollar, which remains above parity with its U.S. counterpart. As China's growth slows and more European countries slip back into recession, the RBA is looking to boost Australia's growth outside the mining industry.

"The tasks of putting European banks and sovereigns onto a sound footing for the longer term, and of improving Europe's growth prospects, remain large," said Mr. Stevens. "Hence Europe will remain a potential source of adverse shocks for some time yet."

Meanwhile, Australia's Treasurer Wayne Swan is putting the final touches on a budget for the next fiscal that is widely expected to include about US$36 billion in spending cuts, tax increases and other added revenue as he strives to deliver a surplus.

Mr. Swan and Prime Minister Julia Gillard have staked the government's political future on Australia's economy, which has outpaced Europe and the U.S. since the global financial crisis in 2008.

"We expect more rate cuts," wrote Gerard Minack, chief economist at Morgan Stanley in Sydney after the RBA's decision. "Further easing will be required, in our view, to counteract fiscal tightening and the still high Australian dollar."

The Reserve Bank of Australia is shifting its focus away from fighting inflation.

That bearish outlook was shared by David de Garis, senior economist at National Australia Bank, who said that financial markets are pricing in a further three cuts in interest rates over the next year.

"Financial markets are pricing in an Armageddon scenario," said Mr. de Garis.

Recent economic reports have raised concerns about Australia's economy. Just this week came data that showing new home sales in March, based on a survey of the country's 100 largest builders, were down a seasonally adjusted 9.4% from February.

Even the standout resource sector has been hit in recent months as China has slowed down. In February, a drop in coal exports produced Australia's second consecutive monthly trade deficit, adding to fears that the economy has slowed sharply in the opening months of 2012.

Business leaders responded positively to the rate cut, which was followed by a drop in the Australian dollar—it was recently at US$1.0308, down from US$1.0400 just ahead of the announcement—and a jump in stock prices. The S&P/ASX index gained 0.8% on the day to finish at 4429.5, its highest close since August.

"That's a very strong message, this is a very good result," said Gerry Harvey, chairman of electricals-and-furniture retailer Harvey Norman Holdings Ltd.

Source: The Wall Street Journal - www.online.wsj.com


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