Bold rates move for a soft landing

AUSTRALIA is still heading for a sharp economic slowdown -- or even recession -- despite yesterday's drastic rate cut.

Bold rates move for a soft landing

AUSTRALIA is still heading for a sharp economic slowdown -- or even recession -- despite the Reserve Bank's drastic 1 percentage point cut to the cash rate yesterday.

The stockmarket rallied as the steepest cut in 16 years was announced but, although they unanimously praised the cut, economists said the fundamental story remains the same -- domestic demand is falling, global growth is slowing, households have borrowed too much and need to pay down their debts -- meaning spending and borrowing growth will slow.

Economists expect the bank to continue cutting rates, down to under 5 per cent by mid-2009, as it attempts to guide the economy to a soft landing.

That is a difficult job because of the global slowdown, with recession in the UK and Europe and slowing growth in important developing economies, including China.

The only thing that may keep Australia's economic growth positive are commodities exports, but even they will have a less pronounced effect, as prices of many commodities has plummeted.

Steve Keen, professor of economics at the University of Western Sydney, described the decision as a "bold move'', but ultimately an admission that the bank had been going down the wrong path earlier in the year.

"It's courageous of them, because it needed to be done, but it has highlighted that the previous tactic of focusing on inflation has failed. I praise Glenn Stevens for doing it, but they must now realise that inflation is far down the list of priorities. It is excessive debt that is the problem, and (he) has acknowledged as much,'' he said.

In a speech last month, Mr Stevens warned that household gross debt had ballooned from 50 per cent of disposable income in the early '90s to 160 per cent and predicted a new era of prudence.

"It is possible that we are witnessing the early part of a new phase where the household spending and borrowing dynamic is different from the past decade and a half,'' Mr Stevens said.

Professor Keen said that, in the past, "rescuing'' the financial system had always led to a new bout of excessive borrowing.

A slowdown or even contraction in borrowing could have a disastrous effect, he said.

"It is necessary, but it will be painful. If we stop increasing borrowing, it will have the same effect as taking $260 billion out of the economy. That means recession."