The Reserve Bank has dramatically downgraded its assessment of the Australian economy ahead of the budget, slashing its forecasts for growth and inflation and opening the door to further rate cuts.
The bank's latest quarterly review issued yesterday predicts ''subdued'' jobs growth, ''weak'' building activity, ''soft'' government spending, weak business investment away from the mining sector and inflation near the bottom of its target band.
Offsetting all of these and allowing the Reserve Bank of Australia to match the expected Treasury forecast of 3.25 per cent economic growth to be unveiled budget night is a strong pick up in export earnings, by itself responsible for 1 percentage point of the RBA's 3 to 3.5 per cent economic growth forecast.
The forecast will enable Treasurer Wayne Swan to claim the economic growth is returning to trend, but the growth will be unbalanced, with the bank expecting only ''modest'' employment growth in the year ahead.
The new outlook is a turnaround from May last year when the Reserve forecast ''solid'' employment growth and the budget forecast 500,000 new jobs in two years.
The RBA says it no longer has faith in counts of job advertisements to tell it what is going on because they do not account for a pick-up in job losses that is going on at the same time.
''Firms in a range of industries continue to indicate that they are cautious about hiring more staff and some liaison contacts expect to reduce headcount,'' the RBA statement says.
Workers who lose their jobs are tending to stay unemployed rather than move to new ones, facing ''a range of difficulties, including the need to retrain or relocate, before they can take advantage of employment opportunities in expanding industries or regions''.
Although Australia's unemployment rate is at present low, the RBA says the prospect of unemployment is weighing heavily on consumer confidence. A recovery in housing construction is ''unlikely in the near term'' with buyers lacking confidence to commit to building contracts.
''What is striking reading the statement is the bank's admission that growth and inflation have clearly undershot its expectations,'' said RBC rates strategist Su-Lin Ong.
''The door remains open for further rate cuts to get key lending rates to more stimulatory levels. We now expect another 0.50 points of cuts this year, enough to get the cash rate to 3.25 per cent.''
Mr Swan welcomed the RBA's statement saying: ''I think this indicates our economic fundamentals are strong. The Australian economy is expected to outperform every other major developed economy in the next couple of years, the outlook for mining investment still looks very strong, and the bank makes very particular reference to our AAA credit rating.''