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Australia's central bank may more than halve its benchmark interest rate as the nation enters a long and deep recession, says former Governor Bernie Fraser.
Fraser, Reserve Bank of Australia chief during the nation's last recession in 1991, said policy makers might reduce the overnight cash rate target to less than 2 per cent from 4.25 per cent now. The bank's board gathers for the first time this year on February 3.
"This recession will be deeper and longer than the last recession in 1991," Fraser said. "The Reserve Bank could go below 2 per cent; they will go as low as they need to and a further stimulus from the Government will be required."
Governor Glenn Stevens has overseen the bank's biggest round of policy easing in almost two decades, slicing three percentage points off the key rate since early September.
The economy grew 0.1 per cent in the third quarter, the weakest pace in eight years, unemployment climbed to a two-year high of 4.5 per cent last month and home-building approvals plunged by the most since 2002, evidence Australia may follow New Zealand, Europe, Japan and the United States into a recession.
Australia's dollar fell to US65.14c in Sydney from US65.54c in late trading on Thursday.
Investors increased their bets that the central bank will cut rates by 1 percentage point next month, according to a Credit Suisse Group index based on swaps trading.
"We're embarking upon what may be one of the most troubled years of our age," Prime Minister Kevin Rudd said two days ago.
"It's a very ugly thing to see."
Treasurer Wayne Swan said the nation was experiencing a "huge shock" and has vowed the Government will unveil further stimulus if the global outlook worsens. Australia already has allocated close to A$45 billion ($55.5 billion) in aid for families, pensioners, bond markets, home buyers, and infrastructure spending to revive growth.
"The Government's language has been all doom and gloom: they're scaring the pants off people and we're talking ourselves into this recession," said Fraser, whose seven-year stint as governor ended in September 1996.
"People are not about to spend their stimulus, which is exactly what needs to happen for confidence to improve."
The economy's 17-year expansion has been driven by global demand for commodities such as coal, iron ore and copper that sent unemployment down to a three-decade low, drove a housing boom and stoked consumer spending.
Now spending has slowed as businesses from airlines to manufacturers fire workers. Westpac Banking's consumer confidence index fell 2.2 per cent this month to 89.9 points, indicating pessimists outnumber optimists.
David Jones, the second-largest department store chain, said this week profit growth would stall this year.
Earnings at Harvey Norman Holdings, Australia's biggest furniture and electronics retailer, dropped 32 per cent in the first quarter.
"Things are going to be difficult in the economy for a while," Fraser said. "It's only going to get worse and that will be for an extended period of time as other economies ... slow." Australia's biggest trading partners, China and Japan, are faltering. China, which accounts for one-fifth of global growth, expanded at its weakest pace in seven years in the fourth quarter and Japan's first recession since 2001 is deepening.
A slowdown in China would reduce Australian exports by A$5 billion, Rudd said. Prices for coal and iron ore shipped from Australia might drop significantly this year, the Reserve Bank said last week. Australia's exports are equivalent to about 20 per cent of GDP.
BHP Billiton said this week it would cut 3400 jobs in Australia as it prunes operations.
During Fraser's time as governor, interest rates dropped from 17.5 per cent in 1990 to as low as 4.75 per cent by mid-1993, according to the central bank's website. The key rate hasn't fallen below 4.2 per cent since the Reserve Bank began publishing its benchmark in 1990.
"The recession in 1991 was short, sharp and severe," Fraser said.
"Interest rates declined and the Government delivered fiscal stimulus and the recovery occurred. This seems a different story and will much more drawn-out."
- BLOOMBERG