Australia cuts rates to escape world recession

Fall in commodity prices and slowing Chinese growth has hit economy hard

Australia has slashed interest rates to try to save the economy from the gathering global recession. The Reserve Bank of Australia cut its benchmark cash rate yesterday by a larger-than-expected 0.75 percentage points, to 5.25 per cent. It follows a 1 percentage point cut last month.

Australia is heavily dependent on China's economic development, and commodities such as coal and copper have been in demand as a result of China's modern industrial revolution. However, the slowdown in Chinese annual growth – from 12 per cent a few years ago to the 9.3 per cent forecast by the IMF for next year – has hit commodity prices, Australian growth and the Australian dollar especially hard. Australia is China's largest source of raw materials; and China has surpassed Japan and the US to become Australia's largest trading partner. As China has caught a cold, so Australia has contracted flu.

Having emerged comparatively unscathed from the credit crunch, Australia now faces the same sort of problems as North America and Europe. One analyst at the Macquarie consultancy described a number of this month's economic indicators as "falling off a cliff".

Glenn Stevens, Governor of the Reserve Bank, said: "Recent reductions in borrowing rates, the depreciation of the exchange rate and the fiscal stimulus will work to assist growth in the period ahead, but deteriorating international conditions and falling commodity prices will have a dampening influence."

Economists now believe that the central bank will bring rates down to 4 per cent by the end of the year, still high by international standards.

Last month, the government announced an AUS$10.4bn (£4.5bn) package (just under 1 per cent of GDP) to cushion the economy from the worst of the slowdown. Measures included one-off cash payments to pensioners and families, and doubling the grant for first-time home buyers.

While generally receiving a good press from bodies such as the IMF and OECD, Australia's economy also has some particular weak points. It has, on some measures, one of the most overvalued housing markets in the world, another engine of growth that has been spluttering of late. And, despite her success in exporting commodities and agricultural produce to developing east Asia, Australia has a large trade deficit; as a proportion of national income, it exceeds those of the US and UK, usually regarded as being unhealthy. Inflation, too, has been high.

The IMF forecast in September that Australian growth will slide to 2.5 per cent this year and 2.2 per cent in 2009, down from the recent peak of 4.2 per cent in 2007.