The Reserve Bank has slashed its key interest rate by 1% to 3.25%, the lowest since 1960.

The bank’s decision, announced at 2.30 pm followed the board meeting this morning and then the Federal Government’s $42 billion spending package at 12.30pm.

In his post-meeting announcement, RBA Governor Glenn Stevens said the board “took into account” the earlier package of measures from the Federal Government:

In making its decision, the Board took into account the package of measures announced by the Government earlier today.

The combination of expansionary monetary and fiscal policies now in place will help to cushion the Australian economy from the contractionary forces coming from abroad.

Note the word “cushion” not protect or save us — cushion — a support. The Federal Government made clear today that its package of measures was designed to “support” 90,000 jobs over the next year and a bit, not save them, or result in the employment of 90,000 extra people. In fact Australia isn’t doing all that badly, relative to the US, Japan, the US or even China where unemployment is rising rapidly.

The policies are all about support for what we have and to lessen the possibility that we will have to take larger job losses and large falls in demand over the next 18 months as the impact of the slump, especially that from recessed Japan, South Korea and Taiwan, and sluggish China, sweeps over us.

Think of that economic phrase, “aggregate demand”: this is what the Government, treasury and the RBA are aiming to do.

Demand was weak in the September quarter, running at negative levels outside the farm sector. That may have been repeated in the December quarter, so now the authorities have to make sure demand in the non-farm economy is maintained and increased in coming months.

That means more retail spending, rising demand for housing and construction, more demand for building products of all types, which can be switched from mothballed mining projects into schools, roads, bridges, highways and the like.

The RBA’s rate cut follows the Federal Government’s revision of growth forecasts for the economy. The Rudd Government expects Australia’s growth to slow to 1% this fiscal year to 0.75% next year — one of the few economies to continue to expand.

Now we have 4% of rate cuts, around 5% of annual Gross Domestic Product in extra government stimulus over the next 18 months or so.

The cut to 3.25% maintains the expansionary policy the RBA board formally adopted at December’s board meeting. With the headline CPI down to 3.7% and the RBA’s own measures at 4.3% and easing, there’s still more scope for rates to be cut if, as expected inflation again falls in coming quarters. The Bank said today that inflation “is likely to continue to decline.”

With the resources and associated sectors contracting quickly, there’s now ample room in the economy for the Federal Government to lift spending in infrastructure and to maintain a pipeline of money into parts of the population that will spend and add to retail demand, while spending in business sectors to replace demand that has gone with the evaporation of the resources boom.

Here’s what the rest of the RBA Governor’s statement said:

There was a significant deterioration in world economic conditions late in 2008.

The effects on household and business confidence of the financial turmoil following Lehman’s collapse, and continuing strains on major financial institutions, saw a significant downturn in demand around the world.

As a result, the major advanced economies contracted sharply in the December quarter, as did a number of emerging market economies. The Chinese economy, though still growing, has slowed markedly. Global inflation, having reached high rates during the middle of 2008, is now declining.

Measures to stabilise financial systems have contributed to an improvement in the functioning of credit markets over the past couple of months. This, in conjunction with expansionary macroeconomic policy measures being taken around the world, should assist in promoting global recovery over time. But the near-term outlook for the global economy is the weakest for many years.

Economic conditions in Australia have also been affected, though less than in other advanced economies. Australia’s financial system remains in a strong condition and large interest rate reductions over recent months have been passed through in substantial measure to end borrowers.

Nonetheless, the combination of last year’s financial turmoil, a severe global downturn and substantial falls in commodity prices has had a significant dampening effect on confidence, and therefore on prospects for growth in demand. Inflation has begun to moderate and, given recent developments, it is likely to continue to decline.

In these circumstances, the Board judged that a further sizable reduction in the cash rate was appropriate, to give further support to demand.

Join the Crikey live blog on the rate cut

Get more Crikey, for less

It’s more than a newsletter. It’s where readers expect more – fearless journalism from a truly independent perspective. We don’t pander to anyone’s party biases. We question everything, explore the uncomfortable and dig deeper.

Join us this week for 50% off a year of Crikey.

Peter Fray
Peter Fray
Editor-in-chief of Crikey
50% off