The Reserve Bank of Australia today lowered its interest rates by 0.5 percentage points, its largest reduction since the onset of the financial crisis, in an attempt to stave off stagnation in the economy, which it fears is growing slower than it should be.

The cut brings interest rates down to 3.75 per cent from 4.25 per cent, and the governor of the bank, Glenn Stevens, said in a statement that:

As a result of changes to monetary policy late last year, interest rates for borrowers have been close to their medium-term averages over recent months, albeit tending to increase a little as lenders passed on the higher costs of funding their books. Credit growth remains modest overall. Housing prices have shown some signs of stabilising recently, after having declined for most of 2011, but generally the housing market remains subdued. The exchange rate remains high even though the terms of trade have declined somewhat.

Since it last changed the cash rate in December, the Board has maintained the view that the setting of policy was appropriate for the time being, but that the inflation outlook would provide scope for easier monetary policy, if needed, to support demand. The accretion of evidence over recent months suggests that it is now appropriate for a further step in that direction.

Stevens assesment of the subdued housing market is widely believed to be a significant part of the reasoning behind the larger-than-expected rate cut. The Financial Times quotes Citigroup's Paul Brennan, "one of the few economists to correctly predict the RBA's move", as saying:

A key reason why we believed the RBA could cut 50bp was that lending rates have risen 10bp or so this year and some of today’s cut probably will not be passed through to borrowers.

According to Brennan, the average Australian mortgage rate has not fallen in the last twelve months, despite the base rate dropping by 1 per cent in that time.

More about the central bank's reasons for dropping the base rate will be revealed on Friday, when the RBA releases its quarterly statement on monetary policy.