Like it or not, Australia’s immediate economic outlook is in the hands of the cast of clowns, fools and the well meaning trying to keep Europe on an even keel and away from the shoals that are attracting the likes of the Greeks and the Italians.

That’s why the Reserve Bank’s rate cut this was ahead of the curve, as economists like to describe policy moves ahead of when they might normally happen.

For confirmation of that, you only have to look in the fourth Statement of Monetary Policy released by the RBA this morning. The RBA now says that while economic growth is forecast to slow this year and next, as is inflation, and unemployment will rise from current levels then settle back to those levels, this will happen if Europe gets its act together and manages to do enough to stave off a complete disaster.

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In its listing of risks to the Australian economy, the RBA made it very clear that the biggest downside risk at the moment is Europe:

“The year-ended rate of CPI inflation is expected to fall below underlying inflation in early 2012 as banana prices return to more normal levels. It is then expected to increase to around 3¼ per cent following the introduction of the price on carbon in mid 2012, before again easing back.

“This general outlook for inflation is conditional on aggregate wage growth remaining at around its current pace. It is also conditional on a pick-up in productivity growth as firms respond to competitive pressures and take advantage of lower prices for capital goods.

“The largest risk to these forecasts is the sovereign debt and banking problems in the euro area, as discussed above. The Bank’s central scenario continues to be one in which the European authorities do enough to avert a disaster, but are not able to avoid periodic bouts of considerable uncertainty and volatility.

“A worse outcome in Europe would adversely affect the Australian economy, and underlying inflation would be likely to decline.”

And inflation would decline because we would be replicating our 2008 slowdown when the GFC tugged the Australian economy to the edge of recession.

So while the outlook for the economy is for more subdued growth, it’s clear from the monetary policy statement that rates were cut because the RBA wants a bit of insurance against Europe failing to get its act together.

After the events of the past five days, that was a sensible move by our RBA, because, as it is clear (but not to the federal opposition and some business and union groups), we are bystanders, hostages to the events in Europe. If they mess it up, we pay a price.

So the RBA’s cut has been made to look prescient by the overnight 0.25% chop by the European Central Bank (to 1.2%) under its new head, Mario Draghi, who replaced Jean Claude Trichet who imposed two increases on a staggering European economy in the middle of the year and helped push it towards the cliff. Now, according to the ECB’s new head, the eurozone in particular is dipping into what he said would be a “mild recession” by the end of the year, making the bank’s rate cut very much behind the curve.

The ECB and the RBA have also had to keep in mind the events of this week in the great Greek bailout drama where the referendum that could have sunk the euro was on, off, may on, maybe off and is now off, definitely. Tonight the Greek parliament votes on a motion of confidence, or maybe it won’t by the time the country wakes up in an hour or two. George Papandreou was still prime minister around noon Australian time. Similarly Silvio Berlusconi is still prime minister of Italy and has promised a set of policy changes some time this month (a promise that is as flexible as a Greek referendum).

But Italy’s debts are still costing a bomb, 6.339% for the 10-year bonds, with the ECB again reported to be a heavy buyer overnight to stop yield rising towards a crippling and crisis-making 7%. Certainly if Berlusconi wasn’t PM and Italy had the chance for a snap poll, then the cost of funding might fall sharply if a sensible politician (and not the racist Northern League) became leader. The Berlusconi discount is crippling Italy’s ability to survive.

So Europe is slowing into a recession, with unemployment rising at 9.7%, inflation high at 3% manufacturing contracting, even in Germany. The UK economy isn’t far behind, despite third quarter growth of 0.3%. In the US Federal Reserve cut its forecasts for growth sharply this week for this year and 2012 and 2013, and it lifted its forecasts for unemployment (the US jobs report for October is out tonight). US unemployment will still be above 6% in 2014 and economists reckon the normal rate of unemployment for the US is around 5% to 5.5%. It is currently 9.1%.

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Peter Fray
Peter Fray
Editor-in-chief
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