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The Globe and Mail

Why Australia's rate cut doesn't herald a global wave of stimulus

Two businessmen are reflected in the black granite facade of the Reserve Bank of Australia (RBA) in Sydney on October 6, 2011.

TORSTEN BLACKWOOD/AFP/Getty Images

For the past two years, hopeful winters have given way to disappointing springs, as the global economy appears to have removed itself from the clutches of the financial crisis -- only to stumble, sapping momentum.

Worries that recent history will repeat in 2012 are about to grow louder.

The Reserve Bank of Australia cut its benchmark interest rate by half a percentage point Tuesday, dropping the cash rate to 3.75 per cent. Only a handful of analysts predicted such an aggressive cut; most anticipated a quarter-point move. The Australian dollar fell, as did bond yields.

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Australia's central bank is something of a herald for shifts in the global economy. Australia's strong trading links with China put RBA Governor Glenn Stevens in the boiler room of the global economy. The central bank slashed its benchmark rate by one percentage point in February 2009 at the height of the financial crisis. It was the first central bank in the Group of 20 to shift away from an emergency setting, raising interest rates in the autumn of 2010.

In a statement, Mr. Stevens noted that global economic growth has slowed and that it likely will continue as a "below-trend pace" for the rest of the year. He said China's economic growth has moderated, and will remain at a "more measured and sustainable pace in the future." Like everyone, Mr. Stevens looks at Europe with trepidation, saying economic conditions there are "very difficult."

But a careful reading of Mr. Stevens's statement raises questions about whether Australia is the crystal ball on the global economy's future that it once was. Australia's central bank is fighting local fires this time. The RBA's relatively low policy setting isn't reflected in market lending rates, forcing the central bank to drop the benchmark lending rate lower.

Australian housing prices declined for most of 2011, and policy makers want to avert a collapse. A "persistently high" dollar also is taking a toll on tourism, manufacturing and other elements of the domestic economy outside the resources sector. Mr. Stevens said Tuesday that growth was "below trend" even though domestic demand grew at its fastest pace in four years. "The exchange rate remains high even though the terms of trade have declined somewhat," Mr. Stevens said.

The RBA's rate cut shows the world economy has lost momentum, and investors and policy makers around the globe will take note. But it seems doubtful the move is a first in a wave of new stimulus measures.

The Bank of Canada, for example, is worried about a housing bubble, not a bust. Mr. Stevens also has the luxury of a benchmark interest rate that is high enough that cutting it might have an impact. Few of his counterparts in advanced economies are so lucky.

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About the Author
Senior fellow at the Centre for International Governance Innovation

Kevin Carmichael is a senior fellow at the Centre for International Governance Innovation, based in Mumbai.Previously, he was Report on Business's correspondent in Washington. He has covered finance and economics for a decade, mostly as a reporter with Bloomberg News in Ottawa and Washington. A native of New Brunswick's Upper St. More

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