Australia Warns of 'Sharp' Europe Downturn

Australia's central bank on Tuesday said there was a "non-trivial" possibility of a severe contraction in the Eurozone economy, leaving the door open for further interest rate cuts in 2012.

The Reserve Bank of Australia (RBA) said downside risks to the global economy from Europe's sovereign debt woes had increased of late "though the timing and magnitude of any effects... remained very difficult to predict".

"The news on Europe had been notably weaker and it remained unclear as to how the current situation would be resolved," the RBA said in the minutes of its December 6 policy meeting.

"It seemed highly likely that the sovereign credit and banking problems would weigh heavily on economic activity there over the period ahead, and there was a non-trivial possibility of a very sharp contraction."

The RBA cut the official interest rate by 25 basis points for a second consecutive month to 4.25 percent in December, and the meeting's minutes, published Tuesday, showed European jitters were its main concern.

Board members saw it as a situation with few easy answers and an outcome that remained "very difficult to judge."

"If recent efforts were successful in moving towards a solution, confidence should improve," the bank said.

"On the other hand, a much worse outcome was possible, involving a severe contraction in the European economy, which would have global effects notwithstanding the capacity of the authorities in Asia to apply more stimulatory policies."

Though the strains in Europe had been somewhat offset by more positive data out of the United States, the RBA said Asia's growth had slowed, noting that central banks in China and Brazil were cutting their interest rates.

Commodity prices had also eased from peaks seen earlier in the year, leading inflation to moderate in a number of key economies.

Domestically, there were signs of solid expansion both within and outside the key mining sector but confidence was muted and the bank said it seemed prudent to offer a "modest reduction" in rates to stimulate activity.

The Australian dollar rose to 99.30 U.S. cents from 99.15 ahead of the minutes on the bank's strong endorsement of the local economy, but analysts said its cautious tone indicated that further cuts could be on the cards.

"The comment that credit conditions had tightened in Australia and that companies remain cautious about increasing hiring shows the bank is very focused on what's happening in Europe and the impact on the economy and banking sector," said Macquarie analyst Brian Redican.