RATES CUT IN RESPONSE TO WORSENING ECONOMIC NEWS

UNCLAS SECTION 01 OF 02 CANBERRA 000353 SENSITIVE SIPDIS STATE FOR EEB AND EAP/ANZ TAGS: EFIN ECON AS SUBJECT: RATES CUT IN RESPONSE TO WORSENING ECONOMIC NEWS REFTEL: A) Canberra 345; B) Canberra 214 ¶1. (U) SUMMARY: The Reserve Bank of Australia (RBA) today reduced interest rates by 0.25% in response to worsening global and domestic economic news and increased reports of job losses. The RBA indicated that while monetary and fiscal policy changes to date have been significant, the further deterioration in the world economy since its last meeting and the consequential slowing of the Australian economy as well as rising unemployment justified a cut in rates. END SUMMARY. DETERIORATING ECONOMY TRIGGERS RATE CUT ¶2. (U) The RBA announced April 7 it would cut interest rates by 0.25% to 3.0%. As RBA Governor Glenn Stevens said in his statement today, the Australian economy is contracting, demand for labor is weakening, and although there are tentative signs of stabilization in China and other countries, sentiment is fragile in the US and other major economies. PREVIOUS RBA DECISION BASED ON OVER-OPTIMISM ¶3. (U) The December quarter national accounts were released in March after the RBA's decision to hold rates (ref B) - and the minutes of the RBA's March meeting (released a few weeks later) wrongly forecast that the Australian economy would maintain positive growth. In the event, the Australian economy actually shrank by 0.5% in the December quarter (seasonally adjusted). RBA Assistant Governor Malcolm Edey later acknowledged that Australia faced the prospect of recession, with zero growth over the period to June 2009. Recent economic news has supported this prediction. ¶4. (SBU) On 1 April 2009, retail sales fell by 2% (seasonally adjusted) in February - the biggest monthly fall in almost a decade and a surprise to analysts who expected the previous rate cut to boost spending. This slump suggests the first fiscal stimulus is fading as consumers pay down debt. There have been increasing job losses in Australia, with more to come, with the Master Builders Association (in its March quarter survey) forecasting up to 100,000 workers could be retrenched over the next 12 months, partly because of a drought in finance for construction projects. Even the rare good economic news for Australia is short-term in nature - while Australia's trade surplus hit A$2.1 billion in February (more than double January's surplus of A$926 million) on the back of growing gold exports, with 33% growth in export sales over the year to February 2009 and a drop in imports due to falling consumption, export income is trending downwards sharply due to revised contract prices with China and Japan for iron ore and coal exports. THE LIMITS OF FISCAL POLICY ¶5. (SBU) The Rudd government's May budget is expected to have official forecasts that the Australian economy will contract by at least 1% in 2009-10. There has been a further deterioration in revenue collections since the unprecedented A$115 billion downgrade to revenue announced in February 2009 (over 4 years). Although monetary and fiscal policy are not formally coordinated in Australia, the RBA is aware of the increasing boundaries on budget stimulus measures (if only because Ken Henry, the Secretary of the Treasury Department is a voting member of the RBA Board). Finance Minister Lindsay Tanner warned on 5 April 2009 that the budget QMinister Lindsay Tanner warned on 5 April 2009 that the budget deficit could reach A$100 billion (US$70 billion) over the next 3 years. Tanner played down speculation of a third financial stimulus and warned of the "very serious challenge" Australia faced in terms of fiscal restraints. IMPACT OF INTEREST RATE CUTS; ROLE OF THE BANKS ¶5. (SBU) Over the last 7 months, the RBA has now cut interest rates by 425 basis points. The RBA has claimed deep interest rate cuts are helping insulate households from the worst of the international economic downturn and have increased the prospects for a recovery of the housing market. On 25 February 2009, Reserve Bank Governor Stevens said the big banks still have room to lower interest rates. He noted the Big Four banks are facing less competition even though the banks have warned funding costs remain high, and they could struggle to pass on any future rate cuts. ¶6. (SBU) COMMENT: The Reserve Bank's decision to cut rates again is CANBERRA 00000353 002 OF 002 a response to its greater concern over the deterioration in the economy and the fading impact of the GOA's fiscal stimulus policies. Falling employment, stock market (and retirement fund) asset destruction and fragile confidence are negative factors making recession more likely and the RBA has sought to reinforce the positive role of interest rate cuts in bolstering consumption and debt reduction. END COMMENT. RICHE