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Australia central bank sees case for early rate cut

Reuters - Tuesday, August 19

By Anirban Nag

SYDNEY, Aug 19 - Australia's central bank saw a case for an early reduction in interest rates to head off a deeper slowdown in the economy, even though inflation remained high, the minutes from its August meeting showed on Tuesday.

The Reserve Bank of Australia's policy board said financial conditions had tightened amid the global credit crunch, but this was not warranted as demand had cooled rapidly.

The restrictive conditions had led households to cut back on borrowing while confidence had sagged at a time when asset values were declining.

"Indeed, less restrictive conditions could soon be called for, otherwise the risk of a deeper and more persistent slowing in the economy would increase," the minutes showed. "On these considerations, a case could be made for an early reduction in the cash rate."

Investors <CSRBA=CSAU> are pricing in at least a 25 basis point cut in the key cash rate when the board meets again on Sept. 2.

"The minutes confirmed the u-turn by the RBA as it adopted a clear easing bias amid a further tightening in financial conditions beyond that sanctioned by the move in official rates," said Su-Lin Ong, a senior economist at RBC Capital Markets.

"We expect the RBA to deliver a quarter-point cut in September, followed by another similar move in October or November," she added.

However, the minutes were not seen adding to the chance of a more aggressive move in September, offering some support to the beleagured Australian dollar.

The RBA left key rates steady at a 12-year peak of 7.25 percent at its Aug. 5 meeting, but it signalled that the next move was likely to be lower.

Last week, Deputy Governor Ric Battellino told lawmakers that authorities would not wait for inflation to come down before cutting interest rates, backing expectations that a rate reduction, the first in seven years, was likely in September.

SEEING THROUGH INFLATION HUMP

The board noted there was still a risk that stubbornly-high inflation could start feeding into wages, though no such evidence had emerged as yet.

"If that occurred, the cost of reducing inflation later would be greater," the minutes showed, particularly given that inflation was expected to remain high in the near term.

"This argued for maintaining the current stance of policy," the minutes showed.

The Board noted that while headline inflation would rise in the immediate future, a softer demand outlook meant that inflation was forecast to decline in 2009 and could be brought back to the targeted range of 2-3 percent by 2010. Annual core inflation is running at a 17-year high of 4.4 percent.

"Given the slower trend in demand, scope to move towards a less restrictive setting of monetary policy was judged to be increasing," the minutes showed.

The global credit squeeze, rising fuel costs and falling asset values have combined to subdue consumer demand and drag on the economy, which had enjoyed 17 years of uninterrupted growth.

The minutes said gross domestic product growth for the June quarter was likely to be sluggish, reflecting the slowing demand in the economy.

The RBA staff also expected a weak outcome in the September quarter amid some softening in the drum-tight labour market. Last week, the RBA forecast non-farm growth to ease to 1.5 percent this year from 4.2 percent in 2007.

Board members noted the country's booming terms of trade would boost national income and the capacity to spend. Still, a weaker outlook for most major economies and renewed strains in financial markets argued for caution.

"On balance, it was now looking more likely that demand would remain on a slower track, and economic growth would be fairly slow, over the period ahead," the minutes showed. (Editing by ;anirban.nag@reuters.com ; +61 2 9373 1871; Reuters Messaging:anirban.nag.reuters.com@reuters.net ))

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