We will get a rate cut from the Reserve Bank this afternoon: the argument though is only over the size of the cut, 0.25% or 0.50%. Debate has concentrated exclusively on the domestic economy, ignoring what is happening offshore. China’s economy is not the problem for Australia any more, it’s all about Europe, and the statement from Reserve Bank governor Glenn Stevens should read against the background of the re-emerging tensions there, not here.  So read the statement carefully, and in a fortnight, what the minutes say.

But before we get to Europe, there were a couple of local figures out this morning that have increased the chances of a 0.50% rate cut. The monthly survey of the Australian manufacturing sector saw a fall to a reading of 43.9%, the lowest in eight months: the fall for April was a large and worrying 5.6%. Some of the sub indexes fell, especially employment and orders, but construction picked up.

And the ABS’s March quarterly house price index showed a 1.1% drop in the March quarter, compared with the revised (up) 0.7% fall in the December quarter. Economists had figures on fall of just 0.5%. And in the year to March, the house price index fell 4.5%. The ABS said capital city indexes fell in Melbourne (-2.2%), Sydney (-1.8%), Adelaide (-0.9%) and Hobart (-2.7%) and rose in Perth (+1.1%), Brisbane (+0.4%), Canberra (+1.2%) and Darwin (+4.4%). These two stats were released in time for the RBA board to assess.

As well, this Friday the bank’s second set of forecasts for the year will be issued in its latest Statement of Monetary Policy and later this month deputy governor Phil Lowe and Stevens are due to make major speeches, where some reaction to the polls and problems in Europe will be looked for.

The French and Greek elections take place Sunday, May 6. Elections are also due in the German state of Schleswig Holstein and a week later, there’s a poll in the biggest state, North Rhine — Westphalia. Waking up next Monday morning and checking what happened in these three polls will be more important than wondering about the local economy. Poor results could see the RBA cut its cash rate to protect the economy against a political crisis in Europe crunching markets there and globally, as the second bailout of Greece threatened to do at the end of last year. Ideally, the RBA would probably like to be meeting today week when it would have the votes in from Europe and immediate market reaction.

Poor political results (a win by Francois Hollande in France and weak results in Greece and Germany) could undermine completely the case for a budget surplus in 2012-13 by way of big cuts in government spending. Conversely, a surprise win by President Nicolas Sarkozy would add support the government’s budget strategy and force the RBA to concentrate more on the domestic economy.

For months the RBA has been more concerned about the threat to Australia’s economy from problems in Europe. It was because of Europe’s then tensions, as much as helping the domestic economy, that we got rate cuts last November and December. And, even though the two rounds of three-year loans to European Banks from the region’s central bank helped stabilise the markets and reduce tensions, political volatility has now replaced that as the driver of tensions. And that will quickly become a source of markets tensions, especially is there’s an outflow of capital from France.

A win in the French poll by the Socialist candidate Hollande will spark a surge in tension and volatility in Europe (especially with Germany), with money flowing out of France into other countries to beat a big jump in tax and other changes. By way of contrast, the Greek poll will probably result in a messier government in Athens, but no dramatic change on the scale that a Hollande win in France would have. Greece’s turn to threaten the EU and eurozone will come later this year when it becomes more apparent that a third bailout is needed. Last week, the Greek central bank said the country’s banks had lost €70 billion of deposits in the past two years, meaning there’s very little left to use to lend to industry or home buyers.

But perhaps the most important polls will be in the two German states on successive Sundays. They could see (as the polls suggest), the government of Chancellor Angela Merkel in deeper trouble as opposition rises among German voters to the country’s bailouts of the rest of Europe. Media reports suggest the crazy Pirate Party (which picked up seats last year in an election in Berlin), could win 10% of the vote, which would put them in near The Greens and Merkel’s coalition partner, the Free Democrats. Interestingly, the Greens popularity seems to be sagging as the Pirate Party lifts its share.

Spain is the current black hole favoured by the markets: it’s back in recession with consecutive growth of minus 0.3%, nearly one in four people (24.4%) are unemployed, the worst it has been since 1994 and around 50% of people under the age of 26 have no jobs. Its banks remain weak and in need of fresh capital. Standard & Poor’s cut its credit rating two levels to BBB last week and then took aim at the ratings of 16 banks. It can’t be rescued, bailed out or supported by European governments, even if the IMF is heavily involved.

Despite what Wayne Swan, Tony Abbott and Joe Hockey might think, there’s a definite swing away from austerity, a la Allemande, towards growth and finding ways to stimulate that. A win by Hollande and poor performances by Merkel’s CDU in the two German state polls, will confirm that swing, which will be resisted by markets and investors. That is why the RBA remains fearful about Europe and its capacity to hurt Australia (via damaging exports from our major customers for our minerals, like China, South Korea and Japan). Even though the US economy is growing and piling higher levels of imports from China, Japan and Korea, it’s not enough to offset the damage that a crunch in Europe would cause.

The RBA understands that Europe could return to again rattle the global economy and financial markets. The minutes of the April board meeting contained this reminder “Europe remained a potential source of adverse shocks in the future.” The future could return to haunt us from next Sunday.