Australia Central Bank Cuts Growth, Inflation Forecasts

In a major downgrade, Australia's central bank on Friday predicted the economy would barely grow at all in 2009, while core inflation would return to its target a year earlier than  expected, seemingly leaving the door open for more cuts in interest rates.

In its quarterly Statement on Monetary Policy, the Reserve Bank of Australia (RBA) said a deepening global  recession had darkened the outlook for exports and business investment, likely leading to a contraction in the  domestic economy this year even after aggressive rate cuts and government spending packages.

"The international situation has deteriorated markedly over the past few months, and this is making for a  much more difficult environment for growth of the Australian economy," wrote RBA Governor Glenn Stevens in the  introduction to the 69-page report.

"Despite the significant stimulus already provided by monetary and fiscal policy, the unemployment rate  is forecast to increase materially over the next year or so," said the statement.

As a result the RBA cut its forecast for gross domestic product growth (GDP) for 2009 to just 0.5 percent,  down from 1.75 percent in its previous statement in November and actual growth of 1.9 percent in the year to  the third quarter of 2008.

Non-farm GDP was forecast to be zero by mid-2009 and only 0.25 percent for the entire year. Growth was  expected to pick up to 2.5 percent in 2010 and return to trend around 3.25 percent in 2011.

Consumer price inflation was forecast to slow to 1.75 percent by mid-year, compared to an actual 3.7  percent last quarter, and run at around 2.5 percent for 2009 and 2010. That was down from previous forecasts  of 3.5 percent and 3 percent.

The central bank's own measure of underlying inflation was seen slowing to 3 percent at the end of 2009  and to 2.5 percent the year after, putting it back within the RBA's target of 2 to 3 percent. Previously, core  inflation was not expected to slow to 3 percent until the end of 2010.

The downgrades to growth came despite major fiscal and monetary stimulus in recent months. Earlier this  week, the central bank cut its key cash rate by 100 basis points to a record low of 3.25 percent, bringing the easing since September to a massive 4 percentage points.

The Labor government this week also announced a package of A$42 billion in infrastructure spending and  income support, following A$10.4 billion of pump-priming late last year. 

The RBA said this stimulus, coupled with the sharp fall in the Australian dollar, would help cushion the  economy but could not offset all the pressure from abroad.

Global growth was expected to be the slowest since World War Two. That was bad news for a small open  economy like Australia that relied heavily on exports of resources like iron ore and coal. Already miners had  cut back sharply on spending and overall business investment was expected to fall through the next couple of years.

Indeed, the RBA estimated that output in Australia's major trading partners would decline by around 0.75 percent in 2009, a vicious reversal from growth of 5.25 percent in 2006 and 2007.

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That in turn, threatened a steep fall in Australia's terms of trade - what it gets for exports compared to  what it pays for imports. This had surged in recent years but the RBA was now looking for the terms of trade  to dive by 20 percent between late 2008 and early 2010, taking around 4 percentage points off national income this year.

"Consistent with the large fall in income, real gross national expenditure is forecast to contract  modestly through 2009, offset by a contribution to growth from net exports as a result of the depreciation of  the exchange rate," the RBA said.

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