Considerations for Monetary Policy The governor proposed that members consider a substantial reduction in the cash rate. The backdrop to members' policy discussion this month included the further evidence of slowing in the world economy, with conditions becoming appreciably worse in the past couple of months. The latest IMF and private-sector forecasts were suggesting that growth in both the developed and emerging economies in 2009 would be significantly lower than thought only a few months earlier. Recent actions by a number of governments and central banks to stabilise their respective financial systems were beginning to take effect, but financial market sentiment remained fragile and evidence of weak economic conditions in the major economies and a significant slowing in many emerging economies was still accumulating. Although the Australian economy had been more resilient than other industrial economies, recent data indicated that a significant moderation in demand and activity had been occurring. With confidence affected by the financial turbulence and a decline in the terms of trade now under way, members thought that more cautious behaviour by both households and businesses would result in private demand remaining subdued in the near term. Given these circumstances and the associated easing in capacity pressures, there would be downward pressure on inflation in Australia over the year ahead. Global disinflationary forces were likely to assist in this regard, though members acknowledged that the depreciation of the exchange rate meant the decline of inflation to the target could take longer than would otherwise have been the case. Members agreed that it was appropriate to shift the monetary policy setting from its current roughly neutral position to one that was clearly expansionary. The board saw a need for the reduction in the cash rate, and bank lending rates, to be large enough to have a noticeable effect on financing decisions of lenders and borrowers. Members also took account of the fact that a board meeting was not typically scheduled in January, given that local markets tended to be relatively thin over the summer break and statistical and survey data, as well as liaison information, were less timely. Overall, members judged that the two-month break between meetings was one consideration in favour of a substantial reduction in interest rates at this meeting. Accordingly, members felt that, on this occasion, a reduction of 100 basis points was appropriate and would contribute to supporting confidence among households and businesses. In particular, a reduction of this size would move monetary policy quickly to an expansionary setting. Given trends in money market yields, the board expected that most lending rates would fall significantly. Members observed that, with the decision at this meeting, there had been a major easing in monetary policy over the past few months. They considered that the setting of monetary policy, combined with the spending measures announced by the Government, which were soon to take effect, and the large depreciation of the Australian dollar amounted to significant stimulus that would support demand over the year ahead. The size of the response to date was judged to be such that a period of assessment of local and overseas events was warranted over the summer. The Decision The board decided to lower the cash rate by 100 basis points to 4.25 per cent, effective 3 December.
