The Reserve Bank’s biggest concern at the moment is the eurozone crisis: those fears have driven the rate cuts in November and this month and judging by a speech in Sydney yesterday from Deputy Governor Ric Battellino.
The banks concerns clearly outweigh the central bank’s current feelings about the Australian economy.
It is clear from his opening comments that the RBA has cut rates to give the economy a cushion should Europe’s woes worsen in the next few months, and it has left itself more room to move should events spiral downwards into a dangerous economic slide.
And fears about Europe flattened markets overnight in Europe and the US after giving Asia a small thumping yesterday.
Our late recovery yesterday from an opening slide, will be reversed today, after the nervous night and especially a slump in commodity prices that is the big concern..
The plunge in the gold price continued overnight as the US dollar rose past $US1.30 to the euro.
Gold shed more than $US90 an ounce last night and has now lost well over $US160 from Monday, a fall of 10% and a correction that has come from nowhere.
And at a time when volatility is rising, along with investor fears, gold and silver have once again failed to hold their value: they are pretty weak ‘safe havens’.
Copper lost 5% overnight, silver 7.5%: both are close to if not in correction territory as those fears about Europe snowball.
This instability therefore makes yesterday’s speech from the RBA official very timely.
Mr Battellino told the meeting that the Australian economy will inevitably suffer spillover effects from the European government debt crisis, but he believes these won’t have a dramatic impact here.
But that does depend on what happens in Europe.
"Over recent months we have all watched with concern the growing financial problems in Europe.
"The problems are multi-dimensional, involving excessive government debt, weak banking sectors, slowing economic growth and marked differences in competitiveness across countries within the euro area. They have become the main threat facing the global economy and the international financial system.
"It is hard to tell how and when the problems will be resolved.
"In the meantime, turbulence continues in global financial markets and most forecasters are now predicting a very significant weakening in the European economy over the coming year as government spending is cut back, credit tightens and confidence declines.
"Given the size of the European economy and financial system, it will be hard to avoid adverse consequences for other parts of the world, though the extent of these spillovers remains an open question.
"At this stage, most forecasters think that growth in the world economy will be only a little below trend in the coming year, though with the risk of a significantly worse outcome," he said.
"The situation is still unfolding, however. The impact on the global economy will ultimately depend on how the European problems are resolved.
"It is possible that a combination of credible fiscal commitments by governments and short-term support from the ECB and IMF will provide a solution that is relatively benign for the European and world economies.
"However, other outcomes, including deflation caused by prolonged fiscal austerity, inflation caused by large-scale debt monetisation, or some disruptive event such as a change in the composition of the euro area, cannot be ruled out at this stage.
"The sovereign debt problems in Europe have escalated over recent months and an unfavourable feedback loop has developed between government debt, the banking sector and the economy.
"The large size of the euro-area economy and the significant role played by European banks in global cross-border banking mean that it is inevitable that there will be spillovers to other parts of the global economy, including Australia," he said.
And Australia?
Mr Battellino believes that with few direct trade links to Europe, strong government finances and a resilient banking system, Australia is well placed to withstand the impact of the crisis on the global economy.
"I remain confident that Australia, with its strong government finances, resilient banking system, relatively low exposures to the troubled countries and strong links to the dynamic Asian region, is well placed to deal with events that may unfold," Mr Battellino said.
Mr Battellino said Australian banks had very little exposure to European sovereign debt, with government bonds from the nations most at risk of a default: Greece, Ireland, Italy, Portugal and Spain, accounting for only 0.2% of Australian bank assets.
Australia also had limited trade exposure to Europe with just 4% of our merchandise exports going to eurozone countries.
"However, the country may still suffer the consequences of a European downturn through higher borrowing costs for Australian banks and a slowdown in Asian economies, including China and India, both of which have with strong trade links to Europe," Mr Battellino said.
"While the direct exposure of Australia to a slowing in European demand is low, the indirect exposure, through the effect on some of our important trading partners, could be significant.
"China and Indi
