SYDNEY, Feb 6 (Reuters) - Australia's central bank on Wednesday opened the door to a possible rate cut as it acknowledged growing economic risks in a remarkable shift from its long-standing tightening bias that sent the local dollar sliding.
"If we see mortgage rates rising more broadly, we might see the RBA become more willing to consider a rate cut in an effort to offset higher funding costs and support heavily indebted household balance sheets", he said.
Commonwealth Bank of Australia economist Gareth Aird also abandoned his previous call for tighter policy.
In his first public statement of the year Lowe said that in terms of which way the official interest rate would move next, "the probabilities appear to be more balanced", where as previously an increase had appeared most likely.
Not surprisingly, the Australian dollar was sent skidding 1.1 percent to a one-week trough of $0.7153.
Nevertheless, our view is that RBA is underestimating the impact of the housing downturn on the economy - both directly via reduced housing construction and also indirectly via reduced consumer spending - and as a outcome we see weaker growth and lower inflation than the RBA is forecasting.
Australia is not alone in having to adjust policy expectations.
The Aussie dollar fell 1.35 U.S. cents in the 24 hours between midday yesterday and today in response to the RBA governor's admission the economy may be weaker than expected. The European Central Bank has also sounded less certain that it will start tightening later this year.
Before the speech interest rate markets were pricing the future as a 50-50 scenario.
While strong infrastructure investment and a strong labour market are helping the Australian economy tick along, Lowe claimed weakening property markets were a "major domestic uncertainty". If that pans out, the RBA expects wages growth and inflation to pick up gradually over 2020.
"We think they'll have to cut twice and that's going to put a lot of downwards pressure on the Aussie dollar".
"The likelihood is that they will have to cut because house prices almost always draw the broader economy into weakness, and they're falling very fast in Sydney in Melbourne and are now falling in all major capitals".
"The vacancy rate is high and there are reports of skills shortages in some areas", Lowe said.
He said the RBA did not see a strong case for a near-term change in the cash rate.
"In the event of a sustained increase in the unemployment rate and a lack of further progress on towards the inflation objective, lower interest rates may be appropriate at some point and we have the flexibility to do this".