Official family reunion

THIS is the interest rate cut that Kevin Rudd and Wayne Swan needed: its aggression reveals a central bank resolve to fight the global downturn working in lockstep with the Rudd Government.

Fiscal and monetary policy are in harmony. The Government and the bank sing from the same script. This signal was imperative for the Rudd Government for economic and political reasons. It comes after three weeks of turmoil provoked by the Government's October 12 unlimited deposit guarantee decision that exposed divisions within the inner sanctum.

The stimulus being imparted to stave off an Australian recession is huge: a hefty depreciation, a $10.4billion fiscal package and the cash rate slashed by two percentage points over two months.

Rudd says the Government is ready for more fiscal stimulus and the Reserve Bank's statement suggests more interest rate cuts are likely.

Above all, Rudd had to avoid any division or perception of division within the official family on the macro response to the crisis. That would have been a crippling blow. A cut yesterday of only 25 basis points was sure to ignite that precise interpretation. Market expectations were that the bank would cut by 50 basis points. Its decision to go 75 basis points would have delighted Rudd and Swan. This action by the bank dovetails with Rudd's warning that the downturn will be difficult, hard and ugly.

It is no surprise that Treasurer Swan stressed yesterday the decision shows the Government and the bank "working in tandem". It contrasts with the October 12 legacy that provoked a freeze on mortgage funds, exposed differences within the official family and documented tensions between the Reserve Bank and the Government.

The deposit guarantee issue has yet to be resolved. But Opposition Leader Malcolm Turnbull smells political blood and will prosecute the issue. While there is no gainsaying the popularity of the guarantee, it raises questions about the Rudd Government's judgment.

None of the big four Australian banks -- NAB, Westpac, Commonwealth and ANZ -- requested or lobbied for the unlimited deposit guarantee. Three of the majors confirmed this to The Australian yesterday while the fourth declined to rebut the point that no such request was made.

In one sense this is scarcely a surprise, as funds at the time were flowing into the big banks. The preference of the Reserve Bank of Australia was for an alternative to the unlimited guarantee.

This is confirmed by the email sent by governor Glenn Stevens the following Friday to Treasury chief Ken Henry saying in relation to the subsequent debate about a cap, "the lower, the better".

The Reserve Bank had been sceptical earlier about the Rudd Government's pre-crisis decision to seek a $20,000 deposit guarantee.

The bank was appalled at the consequences of the unlimited deposit guarantee. Stevens said "the more the guarantee is used, the bigger the problem elsewhere in the system". Within days upwards of $25 billion had been frozen in market-based investments. Stevens put the issue bluntly: if investors wanted the guarantee, they should pay a fee for it.

Westpac's chief executive Gail Kelly said publicly last week that "the deposit guarantee was not introduced because Westpac needed the guarantee". She supported the Rudd cabinet decision given the depth of the financial crisis at the time. But Kelly is reported as saying the level should be reduced over time to $100,000, the figure endorsed by Turnbull before the October 12 meeting.

When the decision was taken, the Government had information that some institutions were suffering a withdrawal of funds and the unlimited guarantee was cast as an essential response.

It is now apparent to blind Freddy that the Government failed to consult properly at the time. This is tied to the bizarre claim coming from sections of the Rudd Government that to have asked the Reserve Bank's views would have compromised its independence.

Last weekend Turnbull asked: "Would any of us seriously contemplate making a decision like that without having the Reserve Bank in the room? Wouldn't you have spent hours and hours going up hill and down dale, what about this, what about that?" He compared it to a war decision without proper consultation with the defence chief.

The Rudd Government says the Reserve Bank was consulted and was part of the decision. Rudd argues that to have settled for only a partial guarantee on October 12 "would have been destabilising in the extreme". The implication is that the unlimited guarantee helped to forestall a run on some institutions.

Rudd's struggle now is to avert recession. But Australia's downturn will be severe and his rhetoric has passed a new threshold of gravity about its impact.

Latest indicators on house prices, manufacturing performance and newspaper job advertisements point to a rapidly deteriorating outlook. The message from Stevens yesterday was that Australia's future growth is weaker than expected. He predicted that inflation "will soon start to fall".

The bank's pessimism about the global outlook is manifest. Stevens sees "significant weakness" in major industrial economies and more evidence that China is slowing, with further consequences for commodity prices and growing global disinflation.

The pivotal next stage is the US presidential result. For the world and for Australia, much hinges on this vote. Two events are crucial in the restoration of domestic American confidence: a clear victory for Barack Obama that mandates decisive action, and early proof that his presidency will centre on the tough-minded economic realism of the Bob Rubin-Larry Summers school as distinct from the soft protectionism of the Democratic Party Left from whence he hails.

With the Bush administration and Republican Party discredited, the US Democratic Party faces its most decisive moment in several decades. Obama must transcend his base to discern the authentic national interest.

US commentators fill our airwaves predicting a historical new era. Be suspicious of such dreams. Obama inherits a genuine crisis. It requires not just his inspiring rhetoric but the delivery of policies that stabilise the financial system, limit the recession and rekindle sustainable growth. Expect Rudd to book a call to the president-elect soonest.