MercoPress. South Atlantic News Agency

Australian markets react to sharp cut in interest rate

Australian PM Kevin Rudd warned of still 'tough times ahead'

Australia's central bank surprised financial market by cutting its key interest rate a full percentage point from 7% to 6%. The bank said the sharp cut was justified given the prospects for growth, even though inflation is currently above target.

Meantime in Japan the Central Bank voted unanimously to keep the basic interest rate at 0.5% for the twentieth consecutive month. Australian Prime Minister Kevin Rudd said the move would maintain financial stability and help Australia in "tough times ahead". The cut, the bank largest since May 1992, was well received by investors and the stock market rallied. Observers had only expected the rate to be cut to 6.5%. The hefty reduction in the cost of borrowing came despite Australian inflation being at 4.5% - well above the government's target of between 2% and 3%. "They are clearly very concerned about the financial crisis and its potential impact on global growth, on Asian economies which they specifically mention, and on commodity prices," said Saul Eslake, chief economist with ANZ Bank. The decision had a positive impact on Australian stock markets. Most banks were expected to begin pass on at least some of the rate cut to mortgage holders. Observers say that the move by Australia adds to pressure on other central banks to reduce rates. Expectations are now growing that the Bank of England will cut UK rates from their current level of 5% later this week and the Fed will follow at the end of October. Japan supported its decision citing a "sluggish" economy and high inflation plus the fact that it relies heavily on exports. Last month, Japan reported that it had experienced its first trade deficit since November 1982. "Strains in global financial markets have intensified in the wake of failures and rescues of US and European financial institutions and there are downside risks to the world economy," the Bank of Japan said. "In addition, weaker income generation reflecting earlier deterioration in the terms of trade could potentially weigh on domestic private demand," it added.