RBA faces rate squeeze amid global economic meltdown

The Reserve Bank may be forced into cutting official interest rates on Tuesday to a fresh record low of 0.5 per cent as the economic crisis caused by the coronavirus outbreak deepens with signs it is debilitating Australia's most important trade partner, China.

As recently as last Monday, financial markets had put the chance of a rate cut at this week's RBA board meeting at less than 10 per cent. The bank had signalled concerns that with interest rates already at 0.75 per cent another cut could encourage a further rise in house values and burden homeowners with more debt.

But that was before the ASX200 shed more than $210 billion in value, the Dow Jones endured its biggest one-week fall since the depths of the global financial crisis, the Australian dollar slipped to US64 cents and commodity prices including iron ore began to drop.

Markets now put the chance of an interest rate cut on Tuesday at 87 per cent as evidence mounts the global economy is facing its biggest hit since 2008. Markets believe the RBA will have rates at 0.25 per cent by year's end.

On Saturday, a key indicator of China's economy suggested the world's manufacturing centre had come to a standstill.

The PMI manufacturing index fell to 35.7 in February, its lowest reading on record. A reading above 50 indicates the sector is expanding.

The non-manufacturing index fell even further, to 29.6 from 54.1 recorded in January, in a sign that the financial impact of coronavirus has permeated all parts of China's economy.

ANZ economists Raymond Yeung and Zhaopeng Xing said index readings showed the entire Chinese economy had effectively been stopped in its tracks as authorities sought to get on top of the virus outbreak.

They said while authorities had claimed many people had returned to work, the index reports plus other signs including a huge drop in coal consumption through major power plants all pointed to an economy that was shrinking.

The head of America's central bank, Jerome Powell, issued a public statement overnight in a bid to assure global investors that the institution was prepared to act.

"The fundamentals of the U.S. economy remain strong. However, the coronavirus poses evolving risks to economic activity," he said.

Fed chair Jerome Powell has again come in for criticism from President Trump.Credit: AP

"The Federal Reserve is closely monitoring developments and their implications for the economic outlook. We will use our tools and act as appropriate to support the economy."

Analysts and markets took that as an indication the bank will cut America's official interest rates - already at 1.5 per cent to 1.75 per cent - by half a percentage point at its meeting in a fortnight's time.

AMP Capital chief economist Shane Oliver, who puts the chance of a rate cut on Tuesday at better than 70 per cent, said if the RBA did not cut that would put upward pressure on the Australian dollar.

The fall in the dollar was helping exporters, offsetting some of the impact of the drop in demand for their goods.

He said with the Australian economy showing signs it was slowing even before the bushfires and coronavirus, the RBA's stated aims of a sharp fall in unemployment and upward pressure on wages were looking even more difficult to attain.

"If the Federal Reserve eases before the RBA, the Australian dollar could start rising again putting more pressure on the Australian economy," he said.

"Things are moving very quickly. Share markets often overreact but the severity of the fall since record highs just over a week ago are warning that the threat to the growth outlook from coronavirus is serious and can’t be ignored."