Australia Cuts Rates, Raises Spending to Lift Economy

Australia's economy got a double dose of desperately needed stimulus on Tuesday as the central bank cut interest rates to record lows and the government pledged billions in new spending in the hope of dodging a recession.

CNBC.com

Citing the grimmest global outlook in many years, the Reserve Bank of Australia (RBA) cut its key cash rate by a bold 100 basis points to 3.25 percent. That brought its easing since September to a massive 4 percentage points, and investors were counting on further easing to 2.0 percent or less by May.

"Policy settings in Australia are now very stimulative," said Michael Blythe, chief economist at Commonwealth Bank.

"The RBA may want to judge what impact these cuts and the stimulus package has on the economy before moving further, but still, it would rather cut too much than not cut enough."

The Labor government waded in with a punchy package of A$42 billion ($26.5 billion) in infrastructure spending and cash payments for low and middle-income earners, aimed at keeping Australia's A$1 trillion economy out of recession.

Stimulus spending announced since September 2008 now totals A$78 billion or nearly 8 percent of gross domestic product, and adds to a raft of packages developed in major economies, including $819 billion in the United States and $586 billion by China.

"This is quite a remarkable fiscal stimulus and clearly intended to avoid several quarters of negative growth through 2009," said Scott Haslem, chief economist at UBS.

"It adds significant support for our forecast that the downturn here is likely to be short and sharp rather than deep and long," he added.

Prime Minister Kevin Rudd will be hoping he's right as the government faces an election late next year that could see them ejected from power if the recession is not long over.

It looks like being a tight call as, even after all this stimulus, the government still expects unemployment to rise to 7 percent by mid-2010, from just 4.5 percent currently.

Only "100"

The market reaction was somewhat perverse, with the local dollar rallying and bonds losing ground, but that was largely because some investors had bet on an even bigger rate cut.

Neighbor New Zealand slashed its main rate by 150 basis points last week, and the U.S. federal Reserve is already down near zero. The Bank of England meets later this week and is widely expected to cut to just 1 percent.

Yet, Australia's economy has not suffered anything like the fallout seen in many developed countries and escaped an outright contraction, thanks in part to a still sound financial sector.

Rate cuts are also proving potent in that they have directly lowered most variable mortgage rates by almost 400 basis points, worth over A$600 a month off average mortgage payments.

Westpac was the first off the mark on Tuesday, cutting its standard variable rate a full percentage point to 5.91 percent. The government has also been in a position to help, having run budget surpluses for nine of the past 10 years.

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Calling his latest splurge an "extraordinary package for extraordinary times", Prime Minster Rudd said it would add 0.5 percentage points to growth in 2008/09 and between 0.75 and 1 percentage point the year after.

The government more than halved its earlier growth forecasts and now predicts the economy will expand by 1 percent in 2008/09 and by 0.75 percent the following year.

Still, analysts doubt Australia can truly insulate itself from the global downturn.

Six of Australia's top 10 trading partners are already in recession. Japan's exports fell by a third in December, and South Korea this week reported a similar drop for January.

The impact took a toll on Australia's trade surplus, which almost halved in December to a lower-than-expected A$589 million as exports of coal slid 11 percent.

Feeling the chill, Australian mining and energy companies are cutting back on capital spending or shelving entire projects until times improve.    

"While these bold fiscal and monetary stimulus are intended to mitigate a potentially deep downturn, a mild recession still appears likely this year for Australia," said Bob Cuneen, a senior economist at AMP capital.

Copyright 2009 Reuters. Click for restrictions.