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Reserve Bank of Australia cuts key rate to 2.25% citing weak domestic demand

The Reserve Bank of Australia cut its cash rate to a record low, saying weak domestic demand and tame inflation in the face of falling crude oil prices will keep output growth below trend for longer. The Australian dollar fell to its lowest in almost six years.

The RBA cut the cash rate to 2.25 percent, the first decrease since June 2013. Heading into today's announcement, traders had put on a 63 percent probability of a rate cut and were betting on almost 60 basis points of cuts over the next 12 months.

"Overall, the bank's assessment is that output growth will probably remain a little below trend for somewhat longer, and the rate of unemployment peak a little higher than earlier expected," governor Glenn Stevens said in a statement. "The economy is likely to be operating with a degree of spare capacity for some time yet."

The rate cut comes after government figures showed the consumer price index rose just 0.1 percent in December from the previous month for an annual pace of 1.5 percent, the slowest since it last reached that level in mid-2012. Stevens said Australian growth "is continuing at a below-trend pace, with domestic demand growth overall quite weak."

The Australian dollar tumbled to 76.51 US cents from 78.05 cents immediately before the statement. The kiwi dollar dropped to 72 US cents from 72.98 cents and climbed to 93.96 Australian cents from 93.46 cents.

Stevens said falling oil prices and the removal of the price on carbon drove down inflation in 2014, although measures of underlying inflation were also weaker. "With growth in labour costs subdued, it appears likely that inflation will remain consistent with the target over the next one to two years, even with a lower exchange rate," he said.

The Australian dollar had declined "noticeably" in recent months although it was still above most estimates of its fundamental value, particularly given the decline in key Australian commodities.

Stevens reiterated the assessment from the last statement on Dec. 2 that global growth was continuing at a moderate pace, as the US economy continues to strengthen and the euro area and Japan weaken. Soft crude oil prices would act to strengthen global output and "temporarily" lower consumer prices, he said.

He repeated that global financial conditions remain very accommodative.

He noted that house prices have risen strongly in Sydney and that there has been stronger growth in lending to investors in housing assets. The bank is working with other regulators to assess and contain economic risks that may arise from the housing market, he said.

Cutting rates today "is expected to add some further support to demand, so as to foster sustainable growth and inflation outcomes consistent with the target" of 2 percent to 3 percent, he said.