Australia central bank cuts rates first time in 7 years

SYDNEY (Reuters) - Australia's central bank on Tuesday cut its key interest rate 25 basis points to 7.0 percent, the first easing in seven years, as it attempts to combat tighter financial conditions amid the global credit crunch.

In a brief statement after its monthly policy meeting the Reserve Bank of Australia (RBA) said it looked more likely the economy would slow enough to subdue inflation over time.

"Weighing up the available domestic and international information, the Board judged that there was now scope for monetary policy to become less restrictive," Governor Glenn Stevens said after the widely anticipated cut.

Still, Stevens also made it clear that any future cuts would depend on how the economy developed month to month, disappointing some investors who had hoped for a green light on more easing.

"The statement is quite a balanced one and has nothing in it to suggest that they will move on rates aggressively," said Su-lin Ong, a senior economist at RBC Capital Markets.

"Markets are a tad disappointed, but we still expect the RBA to move another 25 basis points sooner rather than later."

The Australian dollar initially rose following the central bank statement, which was not dovish as many had expected, but later fell to a one-year low of $0.8448 as the U.S. dollar rallied across the board.

Australia follows neighbor New Zealand in cutting rates, and analysts think Canada and Britain could cut soon. But inflation fears led the euro zone to raise rates in July and many emerging economies are under pressure to tighten as well.

Investors here are still pricing in at least one more RBA cut by Christmas. A Reuters poll of 15 analysts found a 55 percent probability of a cut as soon as October, with a target 6.25 percent in 12 months time.

Tuesday's move had been well priced in after the central bank recently signaled there was scope to unwind some of its past hikes given domestic demand was slowing sharply and financial conditions had been tightened by the global credit squeeze.

Prime Minister Kevin Rudd welcomed the move saying it would put nearly A$600 a year back into family budgets, while being the first easing 740,000 first-time homebuyers had seen.

CHANGING COURSE

The central bank had raised rates as recently as March, lifting them to a 12-year high as it battled a pick-up in inflation.

Indeed, core inflation was still running at 17-year highs of 4.4 percent and the central bank forecasts it will remain above its 2 to 3 percent target band right out to 2010.

Yet, the last few months had also seen household consumption slide in the face of record petrol prices, surging living costs and falling assets values.

In particular, commercial banks chose to toughen lending standards and lift borrowing rates in a scramble to recoup higher funding costs caused by the global credit squeeze.

This extra tightening had a dramatic impact on credit, with growth in mortgages at its slowest in two decades. Figures out Tuesday showed approvals to build new houses fell 5.3 percent in the year to July, even as the country faces a chronic shortage of housing due to a rapidly growing population.

Data on gross domestic product due on Wednesday is likely to show the economy grew a subdued 0.4 percent last quarter, dragging annual growth to 2.9 percent from 3.6 percent in the first quarter.

So sharp has been the slowdown that the central bank's board became concerned it could tip the economy into something much nastier.

"Today's cut is designed to limit the growing risk of recession," said Rory Robertson, interest rate strategist at Macquarie.

"The RBA is proceeding with natural caution, and will cut a long way only if the economy remains weak, unemployment rises and inflation pressures subside," he added.

NOT ALL GLOOM

There are reasons for optimism on the economy.

Australia's booming commodities exports to China and India have showered cash on parts of the economy. Business profits rose at the fastest pace in seven years last quarter, supporting wages and the government's tax-take.

That led to surprisingly strong business investment and firms even upgraded already bullish spending plans for the coming year.

Data out on Tuesday showed spending by the public sector also rose a surprisingly strong 1.4 percent in the second quarter.

Since public spending accounts for just over 20 percent of Australia's A$1 trillion economy, that implied a solid contribution to economic growth in the quarter.

This should lessen the risk that the GDP report would prove

psychologically damaging.

"The mix of tight financial conditions, high petrol prices and low confidence has wrought some damage," said Michael Blythe, chief economist at Commonwealth Bank.

"But the GDP data should also confirm that Australia is better placed than most to deal with it," he added.

(Editing by Tomasz Janowski and Neil Fullick)