RBA Saw `Strong Economic Case' for Australia Rate Cut

By Jacob Greber

Oct. 21 (Bloomberg) -- Increased risks to Australia's economy and signs that inflation will cool gave the central bank a ``strong economic case'' for this month's 1 percentage point interest-rate cut, the biggest since a recession in 1992.

``The material change to the balance of risks surrounding the outlook for growth and inflation in Australia meant that a significantly less-restrictive stance of monetary policy was now appropriate,'' members of the Reserve Bank's board said in minutes of their Oct. 7 meeting, released in Sydney today.

Concern about fallout from the deepening global credit freeze also outweighed the threat that a larger-than-expected rate reduction would erode market confidence already battered by tumbling equities, the minutes showed. Governor Glenn Stevens and his board reduced the benchmark rate to 6 percent as even ``creditworthy borrowers'' were being blocked.

The board considered the possibility that the rate cut ``could have a negative effect on market sentiment,'' the minutes said. ``Members concluded that despite the possibility of a short-term reaction, stronger action would help sentiment over time.''

Australia's dollar pared gains to 70.11 U.S. cents, from 70.18 cents before the report was released at 11:30 a.m. in Sydney. It closed at 70.03 cents late in Asia yesterday.

This month's reduction in the overnight cash rate was twice as much as economists forecast, and took borrowing costs to the lowest since November 2006.

``Members observed that an easing of 100 basis points would bring forward some of the easing markets had already priced in for following months,'' the minutes said. ``The increased downside risks to growth and the improved prospects for lower inflation meant that there was a strong economic case to do so.''

Economy Cooling

Policy makers also signaled in the minutes that they ``did not regard this unusually large adjustment as establishing a pattern for future monetary policy decisions.''

Australia's economy, now in its 17th year of expansion, is cooling as consumers cut spending and banks reduce lending to home-buyers and businesses.

Gross domestic product grew 0.3 percent in the three months through June, the slowest quarterly expansion since the end of 2004, as consumer spending contracted for the first time since 1993.

Unemployment rose to 4.3 percent last month from 4.1 percent in August. Credit provided by banks and financial institutions to home buyers rose 0.4 percent in August, the smallest monthly increase in 22 years, and house-building approvals fell for a second month.

Lehman Collapse

``The path of economic activity had to date evolved in line with the board's previous expectations, with the needed moderation in demand occurring,'' to slow inflation that surged to 4.5 percent in the second quarter. Policy makers aim to keep the rate between 2 percent and 3 percent on average.

``However, the latest economic data predated the onset of the current bout of financial market turmoil,'' the minutes said.

The collapse of Lehman Brothers Holdings Inc. was the catalyst for the ``markedly undermined trust'' among banks around the world. That drove up the cost of inter-bank lending and ``greatly added to banks' funding difficulties,'' the minutes said.

Stevens said on Oct. 7 that ``an unusually large movement in the cash rate was appropriate in order to bring about a significant reduction in costs to borrowers.''

There are signs that some of those costs are starting to ease after the Australian government's decision to guarantee bank deposits last week.

Commonwealth Bank of Australia, the nation's biggest provider of mortgages, cut the price of its variable interest rate home loans yesterday by 21 basis points, to 8.32 percent, following similar moves by National Australia Bank Ltd. and Australia & New Zealand Banking Group Ltd.

All three lenders, as well as Westpac Banking Corp., cut their standard variable home loan rates by 80 basis points in the days following this month's decision by the Reserve Bank.

To contact the reporter for this story: Jacob Greber in Sydney at jgreber@bloomberg.net